Today’s Top Performing Activist Managers Share Traits With Benjamin Graham, the First Activist Investor

Benjamin Graham is often thought of as a studious, professorial fellow who spent his days poring over documents and analyzing public companies in search of bargains.

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But as we saw in part one of our series on Activist Investing, Benjamin Graham, the Father of Value Investing, was also the First Activist Investor – a great securities analyst who also excelled at confronting management in boardrooms and at shareholder meetings.

13D Activist Filings Activist Managers

In 1926 Graham discovered that Northern Pipeline Corp. -- an obscure, illiquid spin-off from Standard Oil a decade earlier -- held $95 in liquid railroad bonds yet traded at just $65 per share.

Graham could have bought Northern Pipeline shares for his fund then bided his time until the market valued the company at its true value. But he had a realization: Northern Pipeline management could quickly and easily close the valuation gap by paying the excess assets to shareholders via a dividend.  It was the shareholders “pot of gold” after all -- not management’s.

But of course management saw it differently. So over the next two years, via relentless negotiation and agitation, including two proxy contests, Graham successfully compelled Northern Pipeline management to distribute its big surplus of capital to shareholders.

In “the Northern Pipeline Affair” Benjamin Graham established the template for activism:  A manager finds a company trading well below intrinsic value, accumulates a sizeable stake, but rather than patiently waiting for an unknown catalyst to close the valuation gap, the manager becomes the catalyst.

Modern day managers have been using Graham’s activist playbook for many years now, and the number of activist campaigns are growing worldwide. According to Activist Insight, 485 companies were subjected to demands by activists through the first six months of 2017. For the full year of 2016, there were 758 announced campaigns.

But as we discussed in part two of the Activist Series, most of these shareholder activist campaigns generate uninspiring profits for the managers and their followers, performance no better than the broad stock market. To realize major profits from following activist managers, investors must zero in on the short list of activist managers that -- like Ben Graham -- excel as both value investors and shareholder activists.

Activist Managers  - 13D Fund

One simple way to invest alongside the campaigns of leading activists is via The 13D Activist Fund (DDDAX). It’s the only mutual fund focused exclusively on following activist managers. With about $290 million under management, DDDAX invests in 20 to 40 activist situations which fund management believes to offer the greatest profit potential.

According to the fund’s website, since its inception in 2012, the 13D Activist Fund has returned 15.73% annually through 6-30-2017. That compares with the S&P 500’s annualized return of 14.72% over the same period. Including the fund’s sales charge, performance is 14.49%. So essentially DDDAX returns have tracked the S&P 500 since 2012. Which isn’t bad considering the great majority of actively managed funds and ETFs have underperformed the market in recent years.

According to 13D Activist’s fact sheet, the fund is “designed to potentially outperform market indices by generating returns that are not correlated to the broader market.”  Indeed, that would seem to be the attraction of an event-driven investment -- it’s not dependent on a broad market uptrend to succeed. However, since inception, the fund’s correlation with the S&P has been high -- 0.81 based on monthly returns. Volatility has been about 25% higher than the SPDR S&P 500 ETF (SPY).

Correlation Analysis
Start Date 2/1/12
End Date 7/31/17
Correlation Basis Monthly Returns
Name Ticker DDDAX SPY Annualized Return Monthly Standard Deviation
13D Activist Fund Class A DDDAX - 0.80 14.63% 3.56%
SPDR S&P 500 SPY 0.80 - 14.48% 2.85%

Source: Portfolio Visualizer

The 13D Fund mimics the investments of the 10 or 12 most prominent and largest managers -- Elliott Associates, Carl Icahn, ValueAct, Jana Partners, etc. It’s hard to argue with this approach, as these managers have built solid track records and reputations over the years.

However, there were over 1400 initial 13D filings in 2016, submitted by hundreds of entities -- one wonders what an investor might be missing by focusing on just a dozen or so of the largest managers.

In fact, the list of the top performing activist funds includes only a few of the most famous activist managers. Below are the top ten activist funds, according to Activist Insight,  based on follower returns per campaign. Only managers with at least five public campaigns since 2010 are included.

Note that many of these funds also employ passive investing strategies, along with short-selling strategies, but the returns below are for their publicly disclosed long-only activist campaigns.
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Activist Average Follower Return % Public Campaigns Count
PL Capital 117.87 12
JCP Investment 111.58 7
Raging Capital 99.33 11
West Face Capital 76.13 6
Nicholas Swenson (Groveland Capital) 74.91 5
Coliseum Capital 74.04 7
Stilwell Value 72.23 25
Northern Right Capital 69.75 10
Laxey Partners 67.78 5
Heng Ren Investments 65.66 5

Source: Activist Insight

Here are the top performing activist investors based on the average annual return followers of their campaigns would have enjoyed. Only activists with 12 or more campaigns since 2010 are included.

Activist Average Follower Return Annualized (%) Average Follower Return (%) Public Campaign Count
Cannell Capital 53.56 36.67 12
Amber Capital 43.12 39.56 12
Clinton Group 36.05 13.87 21
City of London Investment Group 34.9 36.2 12
Relational Investors 33.11 33.43 15
Starboard Value 29.11 34.24 44
Marcato Capital Management 28.14 30.44 16
PL Capital 27.23 122.91 12
Carl Icahn 23.79 62.45 31

Source: Activist Insight

Activist Managers - Copycat strategy?

Follower returns are the returns an investor could have generated by following an activist into a stock when the activist position was announced, either by 13D filing or media announcement. The next closing price after an entry event is used in the calculation. A campaign exit is the next close after the activist fund discloses its exit from the position.

One thing is evident from studying these lists:  The top performing activists tend to focus on small cap stocks. The famous shareholder activists are targeting ever larger companies as their success attracts ever more capital. The average market cap of a company targeted by Elliott Associates last year was $26.6 billion. For Carl Icahn it was $26.3 billion.

Meanwhile the top activist managers -- based solely on performance --  typically target much smaller companies, generally small caps with market values under $2 billion, and even micro caps, with market values under $500 million.

What might explain the superior performance of small cap focused activist investors?

First of all, there are simply many more opportunities in small caps.  According to S&P Capital IQ, there are about 11,500 stocks in the U.S. and Canada with market caps under $2 billion. Only about 1800 have valuations over $2 billion. Among primary and partial focus activists, the sub-$2 billion market cap arena accounted for 78% of all targets in 2016, up from 72% in 2015 and 70% in 2014, according to Activist Insight.

In the first half of 2017, one-third of U.S. companies publicly targeted by activist investors had a market capitalization of above $10 billion, demonstrating increasing focus on large cap targets among activist investors.

But while big stocks are more liquid, smaller stocks tend to be less efficiently priced. A company followed by one or two analysts, with minimal institutional sponsorship and negligible media coverage is more likely to trade below intrinsic value. Benjamin Graham's campaign that launched the activist investor category in 1926 focused on an ignored, illiquid stock.

Very often, large hedge funds shun small and micro-cap stocks for fear of displaying an illiquid portfolio. Many hedge fund investors view funds with small, more thinly traded holdings as riskier than funds holding large caps. Some studies suggest however that because professional investors herd toward actively-traded securities, illiquid stocks generally outperform their more heavily traded brethren.

Small companies may also have poor corporate governance practices compared to larger firms. While big public companies can afford boards comprised of leading executives and can consult top governance professionals, small public companies with minimal budgets typically have no such opportunities. Small cap firms may be less informed about the potential of shareholder activism than their large cap peers and thus are more vulnerable.
While corporate governance may be lacking at many small cap companies, it’s likely no worse than during Graham’s time. In the 1920’s the balance of power at public companies was heavily skewed toward management. When Benjamin Graham approached the Northern Pipeline Co. about giving shareholders their just due, he was met with hostility. After an initial meeting, management told him: “If you don’t approve of our policies, may we suggest that you do what sound investors do under such circumstances, and sell your shares.”

Like Benjamin Graham, the first activist investor, today’s activist managers have no easy task as they seek to close the gap between share price and intrinsic value, and deliver to shareholders the pot of gold that’s rightfully theirs.