A new index that tracks the investments of activist investments is up more than double that of both the stock market and a general hedge fund index.
Activist hedge funds performance
Over the course of nearly a decade, the Novus Activist Portfolio generated returns near 267 percent, more than double the returns of the S&P 500 (INDEXSP:.INX) and the HFRI Composite Index, which tracks general hedge fund performance, a recently released report from Novus shows.
“Cumulatively, the activists trounce both the market and the hedge fund universe in terms of simulated absolute return,” the Novus report, “Actively Tracking Activists, claimed. The report only considers long positions publicly disclosed by the activist hedge funds, excluding any Swaps derivatives contracts and short positions.
While the returns are higher, they come with increased volatility, as measured by standard deviation. The activist investors index has a standard deviation reading of 17.24 percent compared to 14.54 percent for the S&P 500 and a low 6.33 percent for the general hedge fund index.
The upside deviation, or “positive volatility,” was not broken out and compared to downside deviation, or volatility on negative returns. Quantitative investment professionals have used upside deviation to distinguish “real” risk in an investment. While the Sharpe ratio has been commonly used to measure risk and reward, certain quantitative professionals have discredited this measure because it assigns an equal risk rating to upside and downside deviation.
When downside deviation is accounted for as more negative than upside, the results are more interesting. Using the Sortino ratio to assess the risk reward differential in investments, professionals better assess the upside risk relative to downside. This measure shows a 1.07 rating for the activist investors while stocks graded as delivering less positive risk and reward at 0.66 and the HFRI index, which was slightly better at an 0.87 rating.
Activist hedge funds allocations in least liquid investment
While returns and risk rewards measures have been positive, illiquidity can be a little discussed risk factor, Novus points out. The largest allocations by activists tended to be found in the least liquid investment, one where investors are paid a higher return for taking on liquidity risk. “This is the very bucket that rewards activists with a disproportionate win/loss ratio,” the report notes. The report notes that an abrupt change in the liquidity profile of a manager “has historically spelled trouble,” the report notes, pointing to a red flag warning.
Novus Research Director and co-founder Stanley Altshuller noted some of the classic mistakes in an interview with ValueWalk. “One of the costliest activist mistakes was Sears Holdings for Eddie Lampert’s ESL (D filed in 2005) and Bruce Berkowitz’s Fairholme (D never filed),” he notes. “Citigroup was another one – although ESL never amassed a large enough position to have to file a D, Lampert still lost about a $1B on the stock.” The lion’s share of these losses came in the 2008 crises when managers could not liquidate their positions amidst the market volatility and uncertainly, he notes. “This is exactly when liquidity matter most but when a manager is under pressure the market knows it.”
More recently, he notes, there is Pershing Square’s JC Penny (D filed in November 2010).
“These losses, however pale in comparison to the wins. The largest estimated loss is the failed Citi bet for ESL at $1B. At the same time there are 17 trades with over $1B positive (estimated) P&L. Autozone for ESL, Canadian Pacific Railway for Pershing Square, and Valeant Pharma for ValueAct are some of the largest winners ever, netting over (estimated) $2B each for each manager.
Activist hedge funds portfolio composition
To construct the Novus Activist Portfolio, the firm For identified 60 activist managers and combined their publicly disclosed long portfolios (sourced primarily from 13F, D and G filings) into one comingled market value-weighted portfolio containing both active and passive investments. The top five managers in the study, represented by AUM value, were Icahn Management, ValueAct Capital, Fairholme Capital, JANA Partners, and Greenlight Capital.