Media jury still hung on whether activist hedge funds are part of the solution or part of the problem
Last month, The Wall Street Journal published its Activist Investor Report Card, a study of 71 activist campaigns at large companies since 2009. The study aimed to measure whether activists are good for business. The conclusion? “Activism often improves a company’s operational results—and nearly as often doesn’t.” The Journal says that the best corporate response to activism is to analyze the proposal and the track record of the activist making it. Some research.
Not to be outdone, The New York Times published a report on activism in November, complete with its own infographic, Short-Term Thinking. The conclusion? Activists hold stocks longer than people think and the the market would be a better place if everyone had a long-term investment horizon. No wonder people don’t want to pay for news.
In April, this blog noted that media are trying to paint a more holistic picture of activism by asking the key question of are these guys good for the system? As the Journal and Times studies show, the media are undecided on whether activist hedge funds are a productive, corrective force in the capital markets. Part of the problem is that scoring activist success and failure is not the right metric.
There is disconnect in the media between the big picture of activism and the headline grabbing confrontations between activists and corporations. But the media must begin to connect the dots. In the same report on activism, the Times also has a story on corporate governance, saying there is little consensus about what constitutes good governance. Issues like dual class share structures create a world of “haves and have-nots of corporate governance,” writes the Times. 14% of IPOs in the US this year are dual class, compared to 1% in 2005.
How can it be that on the important issue of one share one vote, corporate governance is backsliding and the media continue to be lukewarm at best on activists? Activism is about doing the hard, risky work no one else wants to do. The media need to understand that and acknowledge that there is work in our markets that is uniquely suited to hedge funds..
In discussing a hedge fund lawsuit against the federal government over the ownership of Freddie Mac and Fannie Mae, Bethany McLean, the journalist who uncovered the fraud at Enron, acknowledged the important role hedge funds can play. “It takes someone with a lot of money and ad a lot of power to sue the US government. I think it’s fantastic that we have a group of people who are willing to shine a light on the government’s actions. That’s a value. The transparency that hedge funds can provide is a huge value, not something we should be seeking to get rid of.”
The media need to understand that activism is about much more important than wins and losses. It’s about creating a marketplace of ideas, being a counterweight to corporations and a channel for asset managers to engage with companies about performance. While not all activism is about corporate governance (particularly the recent spike in buyback campaigns), who if not activists will hold companies accountable for governance? Are activists good for the system? If you look at the big picture, the answer is yes.
A commentary in the Wall Street Journal last month by Yale Professor Jeffrey Sonnenfeld marked the start of a new salvo of criticism of hedge fund performance. In the piece, Prof. Sonnenfeld argues that if activists can’t beat the S&P, they have no business in trying to get companies, such as DuPont, which are not underperforming the market, to make strategic changes.
At his annual meeting in Omaha, Warren Buffett gloated that his famous wager with Protégé Partners was still in the money, noting that the cumulative returns in the S&P handily outperformed a hedge fund index since 2008.
The pervasiveness of media focus on hedge fund returns illustrates how unsophisticated media coverage of alternative investment can be. Industry critics, such as Prof. Sonnenfeld understand this and use it to their benefit. It is extremely rare to find citations in the press of the real reasons institutions invest in hedge funds. Institutional Investor, reporting from the SALT conference noted an executive from Wellington saying “people invest in alternatives for five reasons, including to diversify, to add value in a separate bucket and to limit volatility.” But that comment was in response to Greg Zuckerman, the Journal’s long-standing hedge fund reporter who quipped that his 60% stock – 40% bond portfolio beat hedge fund returns.
Returns are not the issue. Nor, in fact are hedge fund fees or hedge fund compensation. There is nothing more elastic than demand for hedge funds. If you don’t deliver on your promise to investors, they walk. End of hedge fund. End of story. That does not stop the media from perpetuating simplistic views of the industry. According to the Journal, at the Ira Sohn conference, Barry Rosenstein of Jana Partners lamented “the media covers activist campaigns like political campaigns, focusing on the horserace rather than on the substance of their suggestions.”
Hedge funds have counter punched. Trian Fund Management defended its returns in a letter to the Journal and Daniel Loeb of Third Point swiped at Buffet during the SALT conference. A new study from UCSD goes right after the Yale data by making a case that hedge fund activism is good for stocks.
To give a forum for activists and their critics, Proxy Mosaic organized a conference call featuring Jared Landaw, GC at Barrington Capital, Kai Leikefett, partner at Vinson & Elkins, and this author. A playback is available.
The numbers from hedge fund supporters and critics will be debated forever and the media will continue to try to keep score without trying to find deeper meaning. When it comes to hedge fund activism, the game is not about wins and losses. The simmering question is are these guys good for our system?
And if you don’t remember the reference in the title to this post, here’s a hint.
The Lead Director Network, an organization of lead independent directors and non-executive chairmen, recently published a paper on trends in activist investing and how boards deal with activists. The paper notes that while activist investing can trace its roots to 1927, several trends are combining to elevate the amount of influence activists have in th market today.
Among the trends cited:
More money: It is estimated that AUM in the activist sector has gone from $12 billion to more than $100 billion in the last 10 years. SkyBridge Capital, a fund of funds, says that it has $4 billion of its $10 billion total committed to the activist sector.
Media interest: Activists are using social media and traditional media as levers and they are exerting influence that is disproportionately large compared to the size of their stakes in a target company.
Going large: In 2009 there were only seven activist campaigns involving companies with market cap higher than $10 billion. Last year there were 42.
Partnering up: Institutional funds like CALSTRS are increasingly working with activists. This powerful trend is a regular subject of this blog, most recently here.
Results: The average return for the activist sector was double that of non activist funds last year. In addition, ISS says that activists won 68% of contested fights for board representation in 2013. This combination of outcomes should only embolden activists.
The change in the balance of power indicated by these trends (which include the top trends of 2013 identified by this blog) have led companies to to realize that ” it is no longer enough to tell shareholders or proxy advisory firms that yo do not like the activists (or their ideas) and that management has a better plan.”
The paper concludes that “companies that maintain an open mind about activism and are willing to acknowledge their own mistakes may benefit from working with any shareholder focused on creating or unlocking value; it is the responsibility of boards and shareholders to determine whether a given activist and strategy qualifies.”
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.
Questions over Herbalife’s business model have resulted in what has been described “the hedge fund equivalent of Stalingrad.” In the midst of this battle royale between hedge funds that on one side include Pershing Square and Greenlight Capital and Third Point on the other, the New York Times raises the question whether short positions should be publicly reported. In the interest of limiting volatility stemming from investor “panic,” the times writes that it if the SEC required that short positions be reported “it would help the market to at least know what the positions are when large short bets are announced, which might help limit panicked reactions.”
That question is above the pay grade of this blog, but what the Times itself does not fully disclose is that there is a high degree of information about short selling already in the market. A number of services track short interest and the cost to borrow stock. Algorithms and trading decision support tools incorporate those data, making the relative degree of short selling in a stock a factor for insitutional traders.
The Times argues that “celebrity investors” can move stock prices with their words alone and that fact might make it difficult for Main Street investors to discern the “truth” about a company. The influence certain asset managers have is undeniable, but it their reputations are earned and their opinions are an important part of the information flow in the market. In the short term, stocks with high levels of short interest might be volatile, but over time, the market sorts out the value. If the short seller is correct, they win. Fast-acting traders win. Mom and pop have a decision to make. That wouldn’t change with a reporting requirement.
And are there not always two sides to the trade? For every short-seller who has become a household name, aren’t there many more long managers with collectively more influence? The Herbalife case has attracted big guns on both sides of the argument — each talking their book — and that’s good for the market. Some, like Bronte Capital have taken to blogging their counterargument to Pershing Square’s thesis.
Is the default reaction of investors to “panic” in the face of potentially bad news as the Times suggests? I don’t think so. Some recent short-driven dramas (Sino-Forest comes to mind) involve very suspect companies, so it should not be surprising that those stocks moved lower quickly. On the other hand, shorts on MBIA and Lehman took years to pay off.
Short selling is a high risk endeavor and the track record of even the most renowned short sellers is mixed. The question of reporting aside, anything that puts a muzzle on short sellers to me will have a negative effect on the market. Don’t shoot the canaries in the coal mines.
Further reading: Oliver Wyman produced a study of effects of short selling curbs on equities markets in the wake of the credit crisis. It finds that markets that require reporting of short positions “become more expensive and difficult venues for all investors to execute both purchases and sales of securities.”
Call it the holiday spirit, but rather than lament the generally sorry state of news reporting about hedge funds, today I want to recognize the best in hedge fund journalism for 2012. We all know that the media is skeptical of the industry and they have reason to be. But, that doesn’t excuse reporters for fundamentally missing the boat on hedge funds as they rehash the same stories about which manager earns what, which trade made the biggest return, and which PM badmouthed which stock. All of that misses the point. The question reporters dance around is why do hedge funds exist and how can managers survive, even thrive, in an ultracompetitive industry where nothing is more elastic than investor appetite for a particular fund or manager.
Periodically, though, the media do get it right. One of the early profiles of Bridgewater Associates (but, ironically, none in the series of profiles that followed) is among these landmarks in hedge fund reporting and so are this year’s winner of the Hedge Fund Article of the Year Award and the runner-up, recognized by this blog.
In second place: “Acting Up,” by Irwin Speizer writing in Absolute Return, June 1, 2012. This article provides an in depth look at ValueAct Capital, the best $8 billion activist hedge fund about which you have probably heard very little. That’s by design, according to Jeffrey Ubben, co-founder, CEO and CIO of the firm. Since its inception in 2000, ValueAct has made 64 core investments and taken 32 board seats at 27 companies — all with only one proxy fight (and that was settled in the firm’s favor before the vote). From its portfolio of companies, ValueAct has influenced 25 CEO changes, 12 major divestitures, and 20 sales of the corporation. According to the article, “In most cases these days, ValueAct is invited to join a board after building a major stake in a company’s stock rather than having to push its way into the room…If there is such a thing as friendly activism, Ubben practices it.”
This article merits recognition because it not only introduces a major firm that has escaped the limelight, but does a great job in documenting the investment strategy of the fund, its investment process, and how responsibilities are shared by its founders. It truly distinguishes ValueAct as a different kind of activist and the facts about the fund’s methodology, track record, successes and failures and expectations placed on investors (the firm has lockups of up to five years) speak much more loudly than the flair typically associated with an activist investor. Several of the better-known activists pursue high-risk, high-reward strategies, and, as a result, media coverage about them is uneven and rarely has a thematic focus on the benefits of the activist strategy. “Acting Up,” in contrast, is a testament to how effective the activist strategy can be and I think it is important to document how a select few managers, Value Act, Starboard Value and others, have quietly had dramatic effect in winning change in the boardroom and generating returns with an activist strategy.
If I had to find any fault, I would like to see more than one client go on the record to discuss their experience with ValueAct and more insight on the firm’s view on or prescriptions for the range of corporate governance issues that plague so many public companies.
Winner: “Caxton’s Law,” by Stephen Taub, writing in Institutional Investor, February 2012. Caxton isn’t the largest hedge fund (although at $9+ billion, it’s plenty big) and it hasn’t kicked off eye-popping returns in recent years (up only 0.7% last year). What makes it among the leaders in the industry is its high degree of operational institutionalization, a culture that embeds solid risk management practices and steady leadership despite the fact that Caxton’s founders retired last year. “Caxton’s Law” wins the Hedge Fund Article of the Year award because it is a best in breed article for both the journalist, who has chronicled critical aspects about a hedge fund that are rarely covered, and the fund itself, which comes across as a disciplined investor and as a firm that goes further than just about anyone to safeguard against losses. The story details three fundamental aspects about Caxton that trip up or even shut down other funds. Each should speak volumes to existing and prospective clients of the firm.
First, is succession. Caxton’s founders retired last year, yet the fund continues to attract assets (AUM is at its highest since 2008). Handing over the reins in an orderly way is no small feat, especially in the hedge fund industry. Indeed, several well-known managers don’t appear to have succession plans. The article documents how new CEO/CIO Andrew Law and new chief risk officer Matthew Wade joined the firm and the degree to which cultural fit and a shared vision of the identity of the fund were part of the hiring process and how Law assumed leadership at the firm.
Next, the article shows how Caxton has managed through market cycles and explains what the firm did in 2007 and 2008 to survive and even thrive during the recent credit crisis. “‘We concluded the order of events of the last five years (2002 – 2007) was over,’ Law recalls. ‘We were entering a new era of economic and policymaking uncertainty, and one that was likely to reward macro trading.'” The firm exited its private equity investments, shuttered non-core trading operations, shorted equities and made the right calls on interest rates. In the process several principals left the firm. What is noteworthy is the fund’s ability to sense a sea change and act with conviction, shrinking itself in the process. It is rare that a reporter gets this kind of back story. From the LP’s point of view, getting this kind of insight about how a manager navigated the most significant shock to the markets in 10 years is rare and valuable. In a world where many hedge funds are one hit wonders and where a significant number of funds close down when the market turns sour, Caxton’s steady performance stands out.
Finally, Taub builds the entire article on the theme of risk management. Whether this construction is by the writer’s design or if Caxton consciously engaged with Taub with this theme in mind is unknown, but the result is one of the most detailed looks into risk management practices at a major hedge fund ever documented by a journalist. The firm is described as having an “obsession with risk management” and Taub writes “managing and controlling risk has always been a cornerstone of Caxton’s success.” “We are disciplined when we don’t understand what the markets are doing,” Law says in the article.
Evidence is given through descriptions of the firm’ risk committee, which includes a rotating member drawn from one of the firm’s senior trading partners, and process by which the firm allocates capital to each portfolio manager. Along with a process to ensure that portfolios have low correlation to each other, the amount of capital allocated to each of firm’s 29 PMs is determined by at least half a dozen factors outlined in the article. Also explained, is how the firm’s “drawdown rule,” which puts traders who are down five percent on ice for three to five days. A trader down 10 percent has to produce a written analysis, discuss it with the risk committee, and sit on the sidelines for a “few weeks.” This policy, which is atypical in the industry, is not viewed as a penalty within the firm. Caxton says it expects PMs to hit the 5 percent drawdown every 18 months. “If a portfolio managers do not reach that mark for several years, they are either very good, lucky or not taking enough risk.”
Congratulations to Stephen Taub and to Caxton Associates. The article should serve as a reminder that the cream of the hedge fund industry includes institutions that are not only savvier than most about the markets, but also have processes in place to make sure that systems and protocols engage to ensure proper risk management. With funds like these, LPs can sleep well at night.