The Alternative Investment Management Association in a new paper credits “activist engagement by hedge funds” with improvement in both the stock price and the operational performance of the companies they have targeted, both while they held the stock and thereafter.
This runs contrary to the common view that activists have been a negative interest because they’ve shortened the attention span of the corporate managers affected.
A corporate management that wishes to entrench itself and avoid interference from activist shareholders, whether hedge fund managers or others, has a range of weapons under the existing legal and regulatory system by which it can do this: classified boards and poison pills chief among them. Even a board divided into only two classes can require activists who are pressing unwanted ideas (or in the extreme a take-over proposal) to persevere through two cycles to replace the intransigent board. And of course boards are free to divide more thoroughly than that.
As scholars have observed, “there is not a single instance where a bidder has successfully won two proxy contests, one year apart, in order to gain control of a target company.” Activist demands often fall far short of takeover (indeed, they usually fall much short of that – this is one of the points of the AIMA paper –= activist hedge funds are not PE funds). Still, the near veto power against hostile bids in existing law surely indicates that potency of the existing entrenchment tools.
The argument against activist hedge funds has long been, to put it bluntly, that entrenchment is a good thing. Entrenched managers are free to lose the corporation’s money this quarter because in their good-faith judgments that will set it up to gain money further down the road. If you don’t like it, Mr/Ms Shareholder, feel free to sell!
The empirical debate over whether such devices as classified boards and poison pills hurt or help shareholder value, or whether perhaps they hurt it in some circumstances and help it in others, and whether if that is the case we can say anything very specific about the defining circumstances – that debate gets very complicated. It might turn for example on what one thinks of Tobin’s Q as a metric for economically meaningful reductions in firm value.
In the new paper AIMA wades into this pool of controversy from the other side. For them it is not: do the anti-activist entrenchments help or hurt? It is, rather, “does the activity of these activists help or hurt?”
As the report observes, there are now a lot of assets under management by activist hedge funds: $120 billion worth.
Broken down by region, two thirds of those hedge funds operate out of North America. The second and third largest chunks are headquartered in Europe or the Asia/Pacific region (15% and 14% respectively.) In both of those regions the prevalence of activist strategies is on the rise.
The AIMA report makes the following points: activist hedge funds are not quarter-by-quarter investors. The average holding period for their investments is two years. Further, they earned 50% compound returns in the period 2012-14, so from the point of view of their own investors they’re doing something right. Likely as a consequence of such results, the activist hedge fund sector has seen a six-fold increase in AUM over the last decade.
More germane for the question of their role within the world of operational corporations: corporate value increases while activists hold their interests, and continues to increase after the funds sell their interest (a 25% improvement on average in the share price of targeted companies in the two year period after an exit.) They are the antithesis of pump-and-dump operators, then, they leave what AIMA calls a “positive and lasting legacy” even when they, well … leave.
The CEO of AIMA, Jack Inglis, summarizes the white paper thus: “Struggling businesses are being turned around, well-run businesses improved, capital more efficiently allocated and the interests of managers, shareholders and other stakeholders better aligned.”
The paper is “Unlocking Value: The Positive Role of Activist Hedge Funds.”