Whether you love them or loathe them, it looks as if activist investors are here to stay.
The number of activist investors and the value of assets following activist strategies have both seen significant growth over the last decade. Between 2010 and 2015 the total value of assets backing activist funds increased from $56 billion to approximately $160 billion.
A report on the activist industry from HSBC points out that this rapid growth in assets under management has a lot to do with the outperformance of activist strategies. Over the last decade, activists as a group have returned 12.6% annualised net of fees, compared to 7.7% return for the S&P 500 over the same period.
The US remains the biggest arena for activist investors with 67% of the 551 activist campaigns in 2015 targeting US corporates. But the European activist scene is hotting up with a 126% increase in activists action since 2010.
Activists: Delivering outperformance
It seems activists have been winning favour with investors thanks to their ability to deliver outperformance that extends beyond the short-term.
Indeed, in the past, it was widely believed that activists were only interested in short-term returns at the expense of long-term investors. However, there is an increasing volume of evidence which shows that activism can deliver outperformance for all investors even after the activist campaigns finished.
HSBC highlights a study from McKinsey of 1400 activist campaigns launched against US companies between 2004 and 2015. The study found that “among large companies, media activist campaigns (activist campaigns carried out in the public domain using specific websites, social media websites such as Twitter, and the press) reversed a downward trajectory in target company performance and generated excess shareholder returns which persisted for at least 36 months.” Further, the report suggests that during the first year of an activist campaign the median total return of a particular equity increased by 5% and this gain remained for at least two years.
Another study, this time by S&P Global found that stocks with the highest combined degree of improvement in return on invested capital and activist share ownership significantly outperformed the wider market.
The studies have significantly improved activists’ reputation among traditional investors, who are becoming increasingly receptive to engaging in dialogue with activists and company managements.
A survey conducted by FTI Consulting of 100 institutional investors (representing $1.7 trillion dollars) found that 78% of investors viewed the growth in activism over the past few years favourably, with 84% believing that activism did add value to a target company. A similar study by Rivel Research Group found that 175 of its sample group of 350 mutual funds had been contacted by activists in 2015 and 43% of these had supported activist actions. BlackRock voted with activists 39% of the time at the 18 largest proxy contests by market cap in 2015.
Keeping companies under control
In many respects, activists can be viewed as the vigilantes of the stock market. In most cases, activists are trying to improve returns for the average shareholder, many of which are small retail investors who lack the funds, time and experience to conduct their own campaigns.
HSBC finds that corporate governance issues, including board composition (director skill set, tenure and diversity), reduced transparency and questionable compensation practices are often issues that are cited by activists within their open letters to target boards. By bringing these issues into the limelight, activists have been to win favour with many traditional investors and are increasingly gaining favour with passive funds who are unable to divest from underperforming companies but have issues with poor corporate governance.
Improving corporate governance standards in the US have also helped facilitate the rise of activism.
The decline of classified boards (allows the nomination of the entire board each year rather than staggered board appointments) and the removal from company articles of shareholder rights plans which can be used to fend off takeovers of the two biggest governance changes that have allowed activists to gain more influence.
Activists had a win rate of 62% for board seat proxy contests based on a shareholder vote in 2015. 50% of activist campaigns in 2015 targeted boards to remove directors, declassify boards and separate the CEO and Chairman roles.
The report notes that while activism is under political pressure in America, the tactics are making inroads in Asia and Europe. Specifically, HSBC opines:
These concerns have been picked up by politicians either directly (senators Elizabeth Warren and Tammy Baldwin have called on the SEC to look into whether buybacks may be a form of market manipulation) or indirectly (Democratic Presidential candidate Hillary Clinton has referred to US corporate buybacks in comments on the short-termism of US corporate culture20). And the pressure on regulators as well as politicians is, if anything, intensifying ahead of the US presidential election in November 2016.
We believe activist growth is more likely to be based on cooperation between shareholders and board members. In our view the key to success for US-based activists conducting campaigns in Europe is their ability to win over and engage with both companies and controlling shareholders. Furthermore the ability to adopt a softer tone has led to positive results. For example ValueAct’s 12.5% stake in Rolls Royce resulted in a seat on their board and the retention of their seat for as long as ValueAct’s stake remains above 7.5%22 believe the UK remains the main market for activists seeking opportunities in Europe and we believe the fostering of investor stewardship though the recently formed Investor Forum23 may potentially help activist investors, primarily by making it easier for them to identify and communicate their interests and campaigns to UK equity investors.
Governments and regulators in Asia are in the early stages of reshaping the corporate and investment landscape, as demonstrated by the recently implemented Japanese Corporate Governance Code and Hong Kong’s Securities & Future Commission’s consultation paper on the Principles of Responsible Ownership in 2015. These developments could signal a more widespread adoption of international best practices in governance and investor engagement.
However, while improving governance may be an entry point for activists we believe that in Asia the cultural resistance to the more confrontational and public US style activism means that cultural awareness is increasingly becoming a key issue. In our view activists who utilise a more friendly engagement approach to their campaigns will have more success in convincing target companies as well as local and international investors to support their aims. The recent reforms in Japan and growth and influence of international shareholders suggest that Japan may be more susceptible to investor activism going forward.
Research by the