The Case for and Against Activist Hedge Funds

Abstract

A subset of so-called hedge funds, henceforth known as “activists”, has latched on the idea that many corporations are not managed or governed in a manner likely to maximize value for shareholders. With the capital they have obtained from pension funds and other institutional investors, they take a small position in the equity of publicly traded companies and push, with a varying degree of aggressiveness, for measures they deem likely to boost targeted companies’ stock price.

This is a fast growing business. The number of activist “interventions”, some 27 in 2000, has reached 345 in 2014 according to the WSJ-FactSet Activism Scorecard. Activist hedge funds have now amassed an estimated $200 billion in managed assets. To achieve more leverage on companies, smaller hedge funds may band in what has been aptly called “wolf packs”. In a by-now familiar scenario, the activist hedge fund calls on the targeted company to name to its board some people of its choosing (threatening a proxy fight if the company is not forthcoming). That is merely a first step, sometimes entirely skipped.

Unless the company swiftly gives in to its demands, the hedge fund will produce a paper, or a long letter, critical of the company’s management and board and outlining the remedial actions that, in its view, would benefit shareholders. That document will be broadcast widely so as to gather the support of the company’s institutional shareholders, even if a tacit one. In due course, if matters come to a proxy fight, the hedge fund will try to persuade the proxy advisors (ISS and Glass Lewis) to come out in favour of the hedge fund’s nominees for the board.

Keywords: Hedge funds, activism, activist hedge funds, institutional investors