It’s hard to imagine how the sun would shine more brightly (or hotly) on activist hedge funds. Pershing Square scored the top spot in Bloomberg’s annual performance ranking for the entire hedgefund industry with 32.8% return. Assets under management in the sector have surged to $120 billion, according to the Alternative Investment Management Association. Funds are taking on US blue chip companies with surprising frequency: Dupont, General Motors, Apple, BNY Mellon, and the list goes on. In step with this ascendancy, the media have started to take a holistic view of activist investing and the basic question is: are these guys good for the system?
Journalists understand that investors and the economy at large benefit from counterweights to entrenched corporate management and boards of directors. The media know that companies, especially large companies, can become complacent and sag under their own weight. The media recognize that it is good to shake up the system now and then. The media, however, are not sold on whether activist hedge funds are a productive, corrective force in the capital markets.
As a result, the reputation of activist hedge funds is at an inflection point at a time when they are at their most prominent, in terms of activity in the market and footprint in the media. Recent media coverage has been thoughtful about both sides of the activist coin. As a group, journalists believe in challenges to authority and are predisposed to accepting the basic thesis of activist investing. In the words of the editors of Bloomberg View, “crafting policies that aim to stifle shareholder dissent is a dumb idea…Suppressing it [the ability of shareholders to turn on managers] with corporate-governance rules that make it harder for shareholders to challenge managers would do far more harm than good.”
The Financial Times credits activists for “advancing the cause of shareholder democracy and good corporate governance, which was otherwise moving at a glacial pace in the hands of traditional institutional equity owners. That is one secular shift that investors can take comfort in, but it brings societal and market-wide benefits, not ones that accrue to activists specifically.”
The Economist echoes the view that other equity owners have done little to advance corporate performance and governance: “they [index managers such as BlackRock andVanguard] have not in the past felt much need to worry about how the firms they invest in are run. Alongside them are the managers of mutual funds and pension funds, such as Capital Group and Fidelity. They actively pick stocks and talk to bosses but their business is running diversified portfolios and they would rather sell their shares in a struggling firm than face the hassle of fixing it.”
However, hedge fund tactics frequently alienate would be allies in the media and fuel criticism of the activist sector, especially as the largest US companies come under pressure from activists. Stock buybacks are an example. About GM’s $5 billion buyback precipitated by Harry Wilson of MAEVA Group and other funds, the Deal Professor column at the New York Times calls the push for buybacks a “worrying trend” and writes, “the haste in which G.M. rushed to comply to Mr. Wilson’s demands, and they and other companies shed cash rather than fight, shows that the activist tide pushing the stock buyback may have gone too far. Let’s hope that it doesn’t wash our companies and shareholders.” The Economist called buybacks “corporate cocaine” and an influential paper from Harvard advocates banning them.
Buyback strategies have driven many of the recent campaigns focused on blue chip companies (a trend noted here more than two years ago). What’s unusual is that about a third of recent corporate targets were outperforming the market when the activist campaign began. Media have questioned the utility of this, especially given the distraction created for management and boards. The Times comments, “trying to break up great companies only weakens one of America’s greatest competitive advantages: the leadership, strength, and adaptability of its global companies. The activists should keep their focus on the underperformers, and work to build the next set of great companies…”
It is too early to judge what Main Street thinks about campaigns to pressure major corporations that by many measures are doing well, but anecdotal evidence shows that small investors give the benefit of the doubt to management. See the comments to this story about Dupont and Trian. If investors tire of a perpetual war with activists, one idea that could gain traction is tenured voting, a way of giving long-term shareholders more voting power than new shareholders. The Wall Street Journal recognizes tenured voting as “providing a bulwark against short-termers who roam the markets, looking to force buybacks or an untimely company sale.”
Then there are the cases of obvious excess that occur with alarming regularity in the the activist sector. Herbalife: a very public case of hedge fund on hedge fund violence. Valeant: a fine line between innovation and insider trading. Now, we have Stake ‘n Shake and its activist counterattack to an activist campaign. The Journal quotes activist specialist Greg Taxin: “One could fairly worry that this [Stake n’ Shake] proxy fight represents the jump-the-shark moment for activism. Serious activism can improve performance and enable more efficient capital markets. This isn’t that.”
We are at an inflection point in the evolution of activist investing. No hedge fund has created a broader narrative about the role of activism in our market system. The jury is still out on whether activists are the market watchdogs they claim to be. The risk is that hedge fund tactics create a backlash and that corporations, with the support of institutions, small investors and even the courts, succeed in changing rules that whittle away at the activist toolbox (proxies, disclosure and short selling, etc) in order to further entrench management.
The SEC acknowledges that there is a debate bout whether activists are good for the market and the economy. While not taking a side (yet), Major Jo White said, “I do think it is time [for activists] to step away from gamesmanship and inflammatory rhetoric that can harm companies and shareholders alike.”
The Economist suggests two possible paths. Activists “could mature to become a complement to the investment-management industry—a specialist group of funds that intervene in the small number of firms that do not live up to their potential, with the co-operation of other shareholders. Alternatively it could overreach—and in so doing force index funds and money managers into taking a closer interest in the firms they own. If that is the way things go, activists could eventually become redundant.”
- T. Rowe Price voted with dissident shareholders 52% of the time in in board contests between 2009 and 2013. Fidelity voted with dissidents 44% of the time.
- Institutional Investor reports that from January through September last year, hedge funds were “somewhat victorious” in 19 of 24 proxy contests they initiated.
- The Shareholder Rights Project at Harvard Law School, in just one proxy season, succeeded in getting about a third of all the S.&P. 500 companies that had a staggered board to eliminate it.
- Even PR firms, law firms and the legendary Martin Lipton (inventor of the poison pill) whose bread is buttered by corporations acknowledge that it is getting harder to fight activists.
Corporate defenders like Mr. Lipton are trying to frame the debate around the issue of long term value. Hedge funds, they argue, are short term opportunists that interfere with corporations’ ability to manage for the long term.
This week Larry Fink, CEO of BlackRock, sent a letter to CEO of every S&P 500 company advocating for greater focus on creating long term value. While the letter doesn’t specifically reference activist hedge funds, it does call into question why companies raise dividends and buy back shares — some of the low hanging fruit that a company use to placate an activist. BlackRock, though, is working all angles. It also is a member of the recently formed Shareholder-Director Exchange which aims to formalize how corporations engage with institutional shareholders. (The Conference Board also has developed a set of principles to increase public trust in big business.) Yet, despite these efforts to work within the system, BlackRock voted with dissident shareholders 34% of the time last year.
There is a real issue tied to short vs long-termism. The ratio of corporate cash to capex is almost at all time low (click to see chart), raising the important question of whether corporations are investing enough to be competitive in the future. It appears disingenuous, though, to suggest that activism is the cause.
If defenders of the status quo are really concerned with long term growth and corporations delivering on long term strategy, they should be as vocal about the myriad of other factors that work contrary to those principles. Take the issue of quarterly earnings guidance. Most companies still provide earnings guidance and presumably manage based on that guidance. I would argue that is a greater short term pressure on corporate America than any group of hedge funds.
In order to capitalize on the tailwinds that are helping activists, they must realize that their reputation is the most powerful weapon in their arsenal. Funds that strike an effective balance between quiet advocacy and calibrated confrontation with boards, establish working relationships with pension funds, and become viewed as positive agents for change by the media, proxy advisory firms and others in the corporate governance arena will be the ones who translate the golden age of activism into riches for their LPs.
In his 1964 study of media theory, Understanding Media, Marshall McLuhan wrote “the medium is the message” to suggest that the way by which a thought is conveyed is more important that the actual message itself. In thinking about a flurry of recent profiles of hedge fund profiles in the press, all you need to know is the title (medium) to know what is being said about the hedge fund (message).
With a medium like Bloomberg BusinessWeek or Institutional Investor’s Alpha, you know what you are going to get: in depth analysis of a manager, what makes his/her strategy successful and some facts about how the fund handles risk management or other critical operating procedures. Recent profiles of David Einhorn/Greenlight Capital and Starboard Value follow a the traditional fund profile template. Two other, even more exemplary profiles, written last year were recognized with the Hedge Fund Article of the Year Award.
At the same time, with a medium like Vanity Fair, you also know what you are going to get: a personality-driven puff piece that is light on investment process and heavy on the cliches that all too often define successful hedge fund managers. This didn’t deter Pershing Square’s William Ackman from participating in a feature in the April issue focused on his well-documented short position in Herbalife. The result is an uneven account of Pershing’s investment that, by outlining fallings out between Ackman and other respected investors, like Daniel Loeb and David Einhorn, promotes the idea that Ackman has a “Superman complex” and “an uncanny knack for….pissing people off.”
If we believe that the medium is the message it should not be a surprise that Vanity Fair emphasized conflict, ego, drama and wealth (of course the writer could not refrain from weaving Ackman’s private jet into the story) over the business of running a multi-billion dollar hedge fund. So why answer the phone when a celebrity magazine calls? I don’t know. The outcome cannot be valuable to a hedge fund’s core audience of institutional investors. Maybe Pershing Square wants to reach a different audience — high-net-worth investors, for example.
Ackman has been playing the media game for a long time and understands the risks and rewards, but anyone else should hang up if Vanity Fair happens to call.
The stock market is at new highs, but, ironically, shareholder activism also appears to be be peaking. High profile activist campaigns involve iconic American brands like Hess, Apple and Dell and smaller companies like Herbalife.
Media love a good fight, so, when hedge funds come out swinging, the newswires light up. This reality is a double edge sword for hedge funds. On one hand, it is usually easy for the activist to corner a corporate target. Typically, the corporation is a sitting duck for criticism and is predictable in its response. However, the media machine must be fed and sometimes it can bite the activist hand that feeds it juicy, controversial stories.
Recently, hedge funds’ tactics have come into question for distorting the information balance that creates an efficient market for a company’s stock. I’d be curious to see a large sample of how stocks perform after appearing in activists’ crosshairs. Stephen Taub, writing for Institutional Investor’s Alpha looks at some recent examples and concludes that “the so-called smart money set may be able to influence a stock’s performance or direction for a day or two or week. But, over a longer period of time the company’s fundamentals…determine a stock’s direction.”
A potentially more ominous story in the New York Times looks at the actors in the Herbalife contest. “The arrival of the hedge fund billionaires — William A. Ackman, Daniel S. Loeb and Carl C. Icahn — spawned a media circus. And at times, some investors acted as if they were the stars of a reality-TV show,” commented the Deal Professor column. The column goes on to say that after playing their cards, Greenlight Capital and Third Point took their winnings and went home, but Pershing Square and Carl Icahn remain at the table engaged in a high-stakes, heads-up death match over Herbalife. The story suggests that things have gotten personal between the two hedge funds and hints that the apparent stand off is no longer about Herbalife, but about ego.
This could be raising the eyebrows of investors and should be a significant concern to Pershing Square and Icahn. If it begins to appear that either remains involved in Herbalife for any reason other than its investment thesis, it could be extremely damaging. Above all, a hedge fund needs to be perceived as rational and must apply an objective, analytic investment process to its strategy in order to deliver on the “hedge fund promise” (a fund’s ability to use all the arrows in Wall Street’s quiver without taking on significantly more risk than the market as a whole to deliver alpha).
This episode illustrates a fact that most activist hedge funds don’t fully grasp: executing the worlds best media program in connection with a shareholder campaign is not a strategy that builds your reputation. It is a tactic that supports a single investment decision. Think about the New York Yankees. Baseball is simple, right? “Sometimes you win, sometimes you lose, sometime it rains.” But the what the Yankees stand for is far bigger than their record. Activists cannot pin their reputation solely to their record because sometimes you lose and sometimes it rains.
Firms must define the bigger picture, the context in which they operate and use the media to tell that story to LPs, prospective investors and corporations (after all, a fund’s reputation alone can be sufficient to deter corporate resistance). This gives the media a larger narrative with which to work and can define the intricacy and nuance of the hedge fund’s game much more than the scorecard. Funds that don’t look inward to find what makes them tick can find themselves winning many battles, but losing in the larger fight to establish and preserve a reputation around which investors want to congregate.
Are banks “un-PR-able?” In the wake of Lehman, subprime, AIG, TARP, TBTF, feasting at the discount window, Libor and the London Whale (the list could go on and on), the answer is probably yes. The complexity of financial products and the scope of the large banks’ operations means that it is not a question of if another scandal will emerge, it’s a question of when. From standpoint of reputation, there is no way to effectively assess and mitigate the multiple risks inherent to global banks.
So what’s a PR guy at [insert name of global investment bank] to do?
Lucas van Praag, former head of corporate communications at Goldman Sachs recently spoke with PR Week about the options. He suggests says that banks need to fight off the instinct to withdraw into the bunker and just focus on corporate social responsibility initiatives. “CSR is important, but [banks] shouldn’t rely on it to repair reputation,” he tells PR Week. Explaining, Goldman’s sometimes confrontational media strategy, van Praag explained that the common link between the firm’s key audiences, including shareholders and regulators, was that “all got most of their information from the media,” meaning that a do-nothing approach was out of the question for Goldman. He goes on to say that “culture is driven from the very top. Banks need to take the initiative to reset the moral compass, and do it often.” The Financial Times echoes this in a recent column, but was more direct, saying it might be “necessary to retire this flawed generation of [bank] leaders.”
Clearly, not all banks have the stomach to spar with media like Goldman once did. In the November 16 issue of Levick Weekly, Candi Wolff, EVP Global Government Affairs at Citi, suggests that the image of banks it tied to the economy and because people believe that banks caused the recession, they will forgive and forget when things improve. “As the economy improves, I think you’ll see an automatic rise in confidence or at least support for banks,” she states. Citi appears to be keeping its head down and focusing on basics. A couple of years ago, it was among the first financial institutions to begin blogging in order to communicate directly with constituents, so it gets the CSR thing, but, for now, is content to play defense. Perhaps the new CEO will change that.
So who is right? I don’t think there is much choice to for banks to play defense and, frankly, pray. Van Praag calls for “structural, operational, and cultural change,” but other than what is mandated by Dodd-Frank and other regulation, change will be slow. Banks simply don’t know when and where the next crisis will hit. How can one realistically take on the skeptics in the media if one doesn’t know what self-inflicted problem is lurking around the corner?