Investing in activist hedge funds requires a tolerance for potential headline risk, the specter of highly public failure, enhanced regulatory oversight and the need to remain invested for the long haul, a panel of institutional investors said at the Reuters HedgeWorld Conference in Chicago today.

Activist Hedge Funds

PAAMCO concerned about activist hedge funds’ negative headlines

With nearly $9 billion under management, fund of fund operator PAAMCO is concerned with headline risk and the process of explaining to clients when an investment in an activist hedge fund makes headlines in a negative way.

Investing in an activist fund can be a “public” experience unlike more private hedge fund investments, notes Justin Sheperd, CIO Aurora Investment Management, an $8 billion fund of funds headquartered in Chicago. “Activism has been a positive contributor to our returns, but does come with volatility,” he said on the panel. “You need to watch the credit cycle, as activists could experience a negative market environment depending on interest rates.”

PAAMCO’s strategy for investing in activist hedge funds

When investing in activist hedge funds, PAAMCO evaluates what the fund is going to add to a company in terms of advice and direction, a strategy used by Kay Torshen, Torshen Capital. “Activists can be an independent eye,” she said, citing the example of General Growth Properties. After the stock had fallen on hard times the principal owner Sam Zell didn’t see the value in the company and “got it wrong.” Activist William Ackman came in to the company, consulted with management on a turnaround strategy and the stock became a high flyer. “Ackman got it right. He saw the value others missed.”

Unlike most long hedge fund investment strategies, which pick stocks and let company management do the work, activist hedge fund managers are more involved. “Being activist takes significant amount of time and involvement,” Torshen noted, saing it is much more involved than investing and sitting on the sidelines.

Long-term investment can be impacted by a long bias

“This is long term investing,” Wrug Ved of PAAMCO said. “It’s not just wait for a pop after an event occurs.” Often times PAAMCO’s investments can last four or more years. “You cannot forecast when the events will impact stock prices,” Torshen said. “Sometimes the investment can be impacted by a long bias in the stock market, but mostly the returns can be rather lumpy.”

When compared to private equity, Torshen noted that activists offer more liberal exit policies, which can be positive and negative. Investors can exit a hedge fund when a deal starts to sour, and such redemptions can have an impact on the strategy.