In a special report on activist hedge funds, Preqin noted the growth of the strategy that is primarily rooted in the US, but noted the potential for global growth.
Fueling this growth is headline performance. Average cumulative returns for activist hedge funds over a 12-month period of time was 11.82 percent compared with an average hedge fund annual return of 7.88 percent. While activist hedge funds have outperformed their hedge fund peers over a five year period, they have done so with increased volatility. When considering returns on a risk adjusted basis, the activist hedge funds fall short on a risk adjusted basis, the Prequin report notes. Sharpe Ratio 0.52 versus 0.77 for all hedge funds. Due to the risk/reward profile the strategy has yet to gain widespread global appeal among institutional investors.
Analysis independent of Preqin notes that the lower Sharpe Ratio could be due to higher upside deviation of activist hedge funds, as stocks subject to activist desires tend to rise rapidly in a short period of time. The Sharpe Ratio and its equal weighting of upside and downside deviation was first questioned in the book High Performance Managed Futures, which conducted analysis showing that the Nobel Prize winning formula provided an equal risk weighting for upside and downside deviation. In activist hedge funds upside deviation could be considered a positive attribute while downside deviation is a negative attribute. For this reason, Sharpe Ratio may not be the best measure of true risk in the strategy.
Activist hedge funds launches
The strategy is growing significantly, the report noted. There were 28 new hedge funds launched with an activist approach in 2013, the highest number of activist funds since 2007, with 66 percent of the funds located in the US.
Activist Hedge Funds’ AUM
Largest activist hedge fund is Elliott International, with $15.6 billion under management. Although the activist strategy is primarily located in the US, two of the larger funds are headquartered in Europe. Cevian Capital II is the second largest activist fund, with $10bn in assets under management, and Cevian Capital closed this fund to new investment in October 2013 as it had reached capacity, the report noted. The Children’s Investment Master Fund in the UK, with $8.2 billion under management, eclipses Third Point Management.
Ninety percent of all institutional investors in activist hedge fund strategies are in the US. Investors in the activist approach are primarily professional and include foundations, which make up 33 percent of the action, followed by private sector pension funds, hedge fund fund of funds and public pension funds.
Preqin notes that a rise in global activist targets could spawn worldwide interest and acceptance of the strategy, but other analysts have questioned the market capacity for the strategy that might limit its growth.