Combating the ineptitude and excesses of poorly-managed company boards as the financial crisis progresses ensures that activist hedge funds are facing what could be their busiest year in the past decade. Here are 10 reasons why, originally put forward in Seeking Alpha.
1. Democrats are in the White House. In the Democrat tradition, the US Securities and Exchange Commission (SEC) should be more supportive of shareholder activists. Republican SEC boards usually support pro-management and Business Roundtable policies. Although the Business Roundtable has empowered certain investors, such as the big Teamsters’ Union pension fund, by enabling them to nominate alternative board members, but not extending this right to vanilla retail or institutional shareholders. But the Obama administration aims to strengthen shareholder rights to promote better governance and investment returns over time.
2. Bigger board battles. The US president will probably appoint an SEC chair that will assert openness, fairness and rights for all shareholders. Specifically, the “proxy access” initiative is expected to return in some form, enabling shareholders to put forward rival board candidates without having to fund a proxy contest against the candidates nominated by the company (which draws on capital supplied by shareholders to present its candidates).
3. Valuations have cascaded. Activist strategies are usually combined with a buy-and-hold approach to an undervalued stock. As value investors, they were hit hard in 2008, but should benefit form rising valuations at some point in the future.
4. Activists will benefit from contraction in the hedge fund sector. The bigger, more stable hedge funds that are likely to outlive many of their smaller competitors will be accompanied by activist funds that have solid track records. That institutional investors understand activist strategies, and know that they don’t involve “black box” processes, will also benefit the managers.
5. Anti-shareholder attitudes are passé. So too, apparently, are lavish salaries and perks. After seeing the market capitalisations of their businesses devastated in 2008, company boards and management have become more sensitive to criticism. Knowing that activists can wield legitimate arguments capable of unlocking shareholder value, companies will be more willing to listen in the next two years.
6. Consolidation will happen. Merger and acquisition activity could resume as stronger companies target smaller firms with depressed market capitalisations. But as companies will be reluctant to play hard-to-get when an attractive buyout arrives, activists will be somewhat passive, similar to Pershing Square Capital Management, which has stakes in booksellers Barnes & Noble and Borders, and is pushing the two together.
7. Activists’ longer lock-ups see them put capital to work while other funds withdraw. Heavy redemptions from hedge funds have not impacted the activist funds so heavily, as they hold longer lock-ups over investors’ capital. Hedge funds with the longest lock-ups should be in stronger positions than their competitors, and activists are usually among them, holding capital for between three and five years. They have more capital to put to work, and can mark investments to market each day.
8. Short-selling bans will help. If short-selling is further limited by regulators, long-only investors, including activist funds, should benefit.
9. Activists will seek balance in their portfolios. Many of the investments that made money in 2008 were short-selling bets. Activists will likely include more short plays in their portfolios to balance the predominance of long-only investments, like investors Greenlight Capital and Pershing Square have already done.
10. There is more fuel for activists. The actions, and lack of action, from various corporate boards in 2008 have provided activists with ample opportunities. Even after Enron and Sarbanes-Oxley, poor oversight impaired major businesses such as Bear Stearns, Lehman Brothers, Citi and General Motors. Rob Rubin, director at Citi, lamented that US housing prices were not expected to fall so precipitously. Although no board is omniscient, many were able to protect shareholder capital, to some extent, during the 2008 meltdown. Activists will pressure badly-performing boards, proving that shareholders have learnt much form the financial crisis so far.
