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.
What’s bigger than Google and Facebook? How about the headlines generated by last week’s “revelation” that Burson-Marsteller, working on behalf of Facebook was trying to generate negative publicity about Google’s privacy policies. Burson reportedly approached reporters at USA Today and privacy advocates without disclosing that the party behind the pitch was Facebook. Release the hounds! The media jumped all over this “story” and the resulting coverage was pretty much universal, online and in print.
Am I missing something here? Is it any surprise to supposedly savvy journalists that companies view the media as another tool to be used to get a leg up on competitors? You would think so from following this incident. The fact is that companies routinely plant negative information about competitors with journalists. The more technical the subject matter the greater the opportunity for companies or their PR agencies to call into question merits of a competitor’s product, service, or business practices. It happens all the time and no one should be more aware than journalists who are in the middle of PR wars.
The tactics of the campaign clearly stunk. However, it is more interesting to me to study Burson’s response once it was confronted. First, it allowed the identity of its client to be disclosed. Why? Second, it admitted wrong doing saying that “…this was not at all standard operating procedure and is against our policies, and the assignment on those terms should have been declined.” That’s not my kind of PR firm. There is nothing wrong with “unbranded” advocacy. It is part of the game and we in the business of selling ideas should not apologize for it.
Why would Facebook even go down this road? Business Insider might be onto something when they write how Google is skimming information from Facebook to help improve its search results.
As for the journalists and privacy researchers who disclosed their conversations with Burson and set off this dust up who were holier than thou when the the opportunity to stick it to a PR firm arose, why don’t you disclose how you get all your story/research ideas? In every story tell us whether it was from a news release, from a pitch from an agency, or if you are doing the story simply to help get future access to corporate sources. Yeah right.
ProPublica suggests that now that PR people outnumber journalists, “private and government interests become more able to generate, filter, distort, and dominate the public debate, and to do so without the public knowing it.” I don’t agree, but the argument shows that we are in a vibrant, competitive marketplace for ideas, brands, and visibility in an increasingly cluttered media landscape. The media needs to own up to their mission and work harder when they detect they are being manipulated. Next time, please spare us the crocodile tears (or at least keep them behind the pay wall).