Monday, June 9, 2014

It’s All in the Packaging: Activist Hedge Funds

It’s All in the Packaging: Activist Hedge Funds

According to Prequin, a compiler of data on alternative investments, activist hedge funds are on the rise.[1]  After a bit of drought in 2011 and 2012 when only 23 funds were launched, money managers have started 28 activist funds in 2013. The term activist fund is not well defined and is ill suited to most hedge funds.  However, investors are demanding activist strategies, so there’s a market to be satisfied. 

Traditionally, shareholder activism was a long-term endeavor in which money managers built significant positions in companies in order to gain a voice in the governance and strategies of the company.  Activism had little to do with hedge funds and was the specialty of a few long-only managers like Relational Investors.  The idea was to earn superior long-term returns by working closely with a small group of underperforming public companies.  Sometimes the undertaking was cooperative, and sometimes it was hostile.

From an investor perspective, activism has a certain appeal because it promises superior returns while also doing some overall good.  The trustees of a pension or endowment aren’t going to need a great deal of convincing in order to endorse activism.   The problem is that true activism is a slow process.  Changing a company’s culture and strategy cannot happen in a couple of quarters.  Moreover, the barriers to change are high because corporate governance laws favor incumbent management.  However, all too many pensions and endowments want quick results, so the hedge fund version of activism has a great deal of appeal.

Hedge funds have adopted the rhetoric of activism with the tactics of corporate raiders and speculators.  Traders like Carl Icahn and Bill Ackmann have created the appearance of long-term activism while continuing to employ the traditional tactics of short-term profiteers.  Moreover, activist hedge fund managers like Mr. Icahn and Mr. Ackmann attack one another over who is a corporate raider and who is a true activist.  In fact, Icahn, Ackmann, Loeb, Einhorn, Singer, et. al. aren’t terribly interested in improving corporate governance or the long-term prospects of targeted companies.  They’re mainly interested in outsized profits.  

According to Prequin, $100 billion in institutional capital is now invested with activist hedge funds.  That figure is likely to grow as more institutions are seduced by the pitch that they can do well by doing good.  Activism isn’t so much an investment strategy as a marketing ploy, and the Prequin report is sure to show up in the pitch books of activist hedge funds.  Set out below is the most seductive of Prequin’s charts.  It shows that activist hedge funds have outperformed all hedge funds for every quarterly period in the past year, and for the past one, three, and five years.

Never mind the fact the comparison is meaningless because the average hedge fund has little to do with activist investing.  Activist hedge funds might more appropriately be compared to a composite of long-only strategies or equity long-short managers or some kind of stock index.    However, the details aren’t important, since it’s all about marketing.  In the hands of a hedge fund marketer, this chart will become objective third-party evidence that hedge fund activism is a compelling way to make money while also improving the shape of corporate America.  The investment strategy isn’t likely to work, but the marketing plan will prove a winner.


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