Activist Investing Primer

There’s no shortage of investing strategies out there today, from investing in the Dogs of the Dow to buying water rights in the Western U.S., but one immensely popular strategy among hedge funds has become activist investing.

Activist investors are generally much different than your run of the mill hedge fund manager that looks to passively invest in securities. Rather, these investors tend to really hone in and have a motive. Many times they are looking to get a seat at the table by getting representatives elected to a company’s board. But still, some activists can effect change with constructive conversations. Generally, we find it useful to know the types of company that are at risk for being targeted by an activist.

One, a key focus of activist hedge funds is, of course, any company that is being mismanaged. These are companies that are not being ran cost effectively, or economically, and could include missed market opportunities. One of the most famous cases of late was Darden Restaurants.

Two, another type of business that is at risk for an activist investor is any company that could be run more profitably as a private company, or where a turnaround would be more effectively done outside the public market spotlight. This means that companies have a great concept, but sometimes there’s the potential for growth /increased profitability that will spur private equity investors to step in and take a company private. The most recent example of this was PetSmart; solid concept, but its retail business model will be better ran as a private business.

Now, there’s a lot of in between related to the above. Such as, an activist investor could look to boost profitability by spinning off underperforming businesses. There’s also the idea that some companies have too much cash, or not enough debt. In that case, activist investors will push companies to increase their dividends or buybacks.  

Some activist investors have more of a speciality.  Elliott Associates  tends to be big buyout pusher.  Marcato Capital  looks to unlock “hidden” real estate value.  Blue Harbour  tends to invest with an eye toward private equity, whether it be trying to boost profitability or trying to attract PE firms for a buyout.  Red Mountain  runs its small fund like a PE firm, taking large stake in small companies and working constructively with management to identify and target growth opportunities.  Starboard Value  and  Carl Icahn  have proven to be a bit agnostic, targeting companies and forcing them to merge, split, boost buybacks and shake up management.

That being said, some see activist investors as a hindrance. Some investors are perfectly content with the way their company is being run. And some investors argue that activist investors are just short-term owners looking to make a quick buck at the expense of long-term shareholders. But at the same time, activist investors do help effect change in companies where retail investors have little or no say.

Further reading —head over to the academic research database, Social Science Research Network, and search for “shareholder activism” and spend a few hours. A particular piece worth reading is Alon Brav and Wei Jiang’s working paper titled  The Long-Term Effects of Hedge Fund Activism . Here’s an excerpt:

Bebchuk, Brav and Jiang find that buy and hold stock returns are on average positive in the three-years and five-years after the Schedule 13D filing. In doing so, they control for the returns on the market portfolio and the returns on small size, value and momentum portfolios (often referred to as the four-factor model of stock returns). These positive average long-horizon abnormal returns have also been found in other studies.