Are Activist Hedge Funds and Other Institutional Investors friends, enemies or frenemies? Additionally, so-called activist hedge funds are often considered a nuisance or even as a necessary evil, notably because of their focus on short-term gains. But do they bring more to the table?
The answer to the question is a resounding yes, according to a study out of Canada. Researchers at the University of Prince Edward Island believe hedge-fund activism generates abnormal returns over both the short run and the long run, without increasing stock return volatility.
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“These findings hold regardless of whether investment horizon is based on portfolio churn rate or type of institution,” said Andrew Carrothers, the author of the study.
On average, the study found a share price increase of three percent from 10 days and one day prior to an event such as a Schedule 13D filing. On the event day and day after, share price rose an additional two percent. By 20 days after the event, the total cumulative abnormal return was seen to be 7.1%, or an even higher 8.1% in an alternative window of 40 days after the Schedule 13D filing.
Overall, 61.4% of the activism events studied had a positive cumulative abnormal return in the 40-day window. By percentile, the CARs for the +/- 20-day window were: -34.6% (5th), -6.0% (25th), 5.0% (50th), 18.9% (75th), and 48.4% (95th). Carrothers also concluded that hedge-fund activism led to better governance and improved performance at the target firm, thereby adding to shareholder wealth.
In the study, Carrothers found that hedge funds are more likely to target firms with high levels of institutional ownership – the probability increasing by 4.0% for a one standard deviation increase in the level of institutional ownership. This preference, presumably, emerges from a desire to benefit from the influence of institutional investors over target firm executives and boards, lower activism costs, and win explicit voting support in hostile proxy contests. The hedge funds also lean toward short-term focused institutional investors, presumably because of shared interests, and sometimes yield an opportunity to acquire initial ownership positions from block sales by institutional investors.
“The behavior of institutional investors suggests that they view hedge fund activism favorably — long-term investors hold their positions to profit from long-term abnormal return; short-term investors take profits but, in aggregate, return seeking more.”
Finally, the study considered the question: Do other institutional investors reflect a positive view of hedge funds?
By examining trading patterns, the study found that institutional investors are heterogeneous in their response to hedge fund activism. Short-term focused institutional investors sell to capture profits and higher returns, and don’t sell their position merely because they dislike activism. Similarly, long-term focused institutional investors maintain their holdings in target firms after the 13D filing because they want to benefit from long-term compounded returns that are better than those generated by the market, the study said.
Overall, the study’s findings suggest a mutually beneficial relationship between activist hedge funds and other institutional investors.
Carrothers, Andrew Glen, Friends or Foes? Activist Hedge Funds and Other Institutional Investors (February 15, 2017). Carrothers, A. (2017). Friends or foes? Activist hedge funds and other institutional investors. Economics and Business Review, (3)17 No. 1, 38-72.. Available at SSRN: https://ssrn.com/abstract=2999977