Understanding and navigating a new world of heightened investor scrutiny
No recent development has influenced firms’ strategic and financial decision-making as profoundly as the surge in shareholder activism following the global financial crisis. From a few activist funds managing less than a total of $12 billion in 2003, the activist asset class has ballooned to more than $112 billion in assets under management for activist hedge funds with most of that growth occurring since 2009 (see Figure 1). These figures are in addition to the significant capital focused on activist strategies by multi-strategy funds. Today, more than 10 activist funds (activist or multi-strategy funds) manage over $10 billion each, or about as much as the entire asset class 10 years ago for each fund. This significant inflow of capital into the asset class comes with immense pressure to put capital to work quickly, and in ever-larger campaigns. Adding to the dynamism of this asset class, new funds are entering the shareholder activism arena at a rapid pace (typically lieutenants of established activist funds or non-activist fund managers pursuing activism as a new strategy) and traditional institutional investors increasingly support—directly or indirectly—shareholder activist campaigns.
While other hedge fund categories may affect companies’ stock prices over time, activist funds seek a direct impact on the day-to-day management decisions of the companies they target. Indeed, activist funds engage companies and propose changes to the status quo. In contrast, traditional investors typically take a position in a company because they are supportive of current management and strategy. In light of activists’ expanding and far-reaching influence, we present this report to guide senior executives and directors who are increasingly likely to face activists at some point during their tenures.
In this report, we highlight why shareholder activism is likely to keep growing, explain the changing tactics of activists and responses of targeted firms, and provide perspectives and recommendations on how to balance short-term activist pressures with the desire to create shareholder value in the long term.
An asset class to reckon with
[drizzle]Who are activist funds?
There are three broad categories of activist funds:
(1) Established pure-play activists: The principal investment strategy of these funds is to generate risk-adjusted excess returns (alpha) by taking stakes in companies, engaging management and proposing their views of a superior path to shareholder value creation. Many of these firms are now household names with significant media, public and investor followings. Thanks in no small part to their past successes, several of these funds now manage well over $10 billion of assets and are therefore willing and able to target even the largest firms.
(2) New activists: New activist funds are constantly being launched with many being led by the former lieutenants of established pure-play activists. Many of these firms are focused on quick results to create a brand and track record to drive fundraising. In addition, many non-activist fund managers have observed the significant attention and asset inflows aimed at shareholder activism and have adjusted their strategies or launched new funds focused on activist strategies.
(3) Multi-strategy hedge funds: These funds are typically diversified and follow a variety of strategies. They have broadened their traditional “passive” approach to include activism in an effort to generate alpha. These funds may pursue target companies with an activist strategy specifically in mind, but also may take an initial “long-only” position and evolve to a more activist-oriented approach over time.
Generating alpha
Not all activist campaigns are successful, and not all funds are successful, but activist funds as a group have been successful at generating significant alpha. Over the short term, market reactions to the announcement of activist campaigns are generally positive by 2–3% relative to the broader market (see Figure 3). The actual outperformance is likely higher because stock prices of targeted companies tend to run up prior to the initial public campaign announcement while activists are accumulating their stake and other investors take positions based on rumors of potential activist interest in the target company. In addition, activists often utilize options to build their stakes, providing more upside if the market response is positive. While rising tides tend to lift all boats, shareholder activists aim to provide positive returns in down markets and outperform in bull markets.
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