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Boardroom battles: Why activist hedge funds are back in the spotlight

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From the new UK chancellor’s career background to the latest campaigns from the best-known US managers, activist hedge funds are firmly back in the spotlight, not least after a stellar 12 months of performance.

From the new UK chancellor’s career background to the latest campaigns from the best-known US managers, activist hedge funds are firmly back in the spotlight, not least after a stellar 12 months of performance.

Before being named Chancellor of the Exchequer earlier this month, Rishi Sunak originally cut his teeth at The Children’s Investment Fund Management (TCI) – Sir Chris Hohn’s well-known activist giant which made 41 per cent last year – later co-running London-based long/short equity fund Theleme Partners before going into politics full-time. 

Meanwhile, across the Atlantic, Elliott Fund Management, the USD35 billion activist firm known for the combative investment style of its billionaire founder Paul Singer, has been pushing for improved governance and transparency at Japanese tech giant SoftBank Group after unveiling a USD2.5 billion stake in the company earlier this month. 

Elliott – who famously took control of Italian Serie A team AC Milan in 2018 following a fierce wrangle with previous owner Li Yonghong – has also zeroed in on Amsterdam-listed NN Group, taking a 3 per cent stake. 

More recently, Daniel Loeb’s New York-based Third Point has steadily built a USD2 billion position in Prudential, with the reported aim of persuading the UK insurance giant to separate its US and Asian businesses, which Third Point believes would unlock value. 

Encompassing an assortment of approaches – ranging from the prickly high-profile public battles common in the US to the more conciliatory, behind-the-scenes discussions that typically underline campaigns in Europe – shareholder activist hedge funds have often come under fire due to the trenchant stances taken by many of their leaders.

Nevertheless, the strategy has frequently provided attractive returns for investors who have the tolerance for the at-times stormy public campaigns. Indeed, 2019 proved to be a memorable year for the strategy, with managers posting an average 13.3 per cent return, according to data from eVestment. The gain represented a storming comeback for activism-focused hedge funds following a torrid 2018, when they tumbled more than 10 per cent for the year. 

“Activist hedge funds’ approaches are constantly evolving,” observes Kai Liekefett, chair of the shareholder activism practice at Sidley Austin LLP in New York. 

“In recent years, we have seen activists use a wide variety of approaches – from the early private engagement under the radar a year before the next proxy season, to the surprise nominations on the last day of the director nomination deadline for shareholders, and a broad range of tactics that are in-between those extremes.”

Constructive engagement

“Our first attempt is always to sit down with companies and to discuss our point,” says Till Hufnagel, head of activism at Petrus Advisers, the USD450 million European manager whose long/short special situations fund generated a remarkable 43 per cent last year, and is so far up an eye-catching 11.5 per cent in 2020.

Petrus focuses on companies with a EUR1 billion to EUR7 billion market cap, in core Europe with a particular focus on the German-speaking region, where there is a fundamental, value-based opportunity.

Petrus’s activist approach often involves escalating its investment cases further following initial discussions, a process which may include press campaigns, proxy battles, or even taking target companies to court in certain situations “when things have gotten out of control”, explains Hufnagel.

The firm, which currently has an activist portfolio of between 8 and 12 positions along with an alpha short portfolio, hit the headlines last month when it sold its 8 per cent stake in Comdirect Bank to Commerzbank for some EUR170 million following a protracted two-year campaign.

Yet Hufnagel – who earlier spent 14 years at Goldman Sachs as managing director in its private equity business focusing on Germany, industrials and natural resources – believes it is becoming easier to engage with target companies in the initial stages. Management, boards and advisors increasingly understand – and better appreciate – what activism means, and how it can add value. 

“More and more companies are actually constructively engaging with us behind the scenes, which is always obviously our preference. When people start doing their homework and once they learn about us through public campaigns, they realise that it might make sense to engage, so that makes the starting point easier,” he observes.

Reflecting on investor appetite for activism, Liekefett maintains that activism has become more mainstream and socially acceptable, but cautions that institutional investors “have come to understand that not all activists are created equal.”

“Hedge fund activists are no longer seen as ‘economic terrorists’ per se,” he observes. “At the same time, investors have started to realise that while some activists create value, others really – sometimes inadvertently – destroy shareholder value.”

Building on this point, he points to the way in which ESG (environmental, social and governance) has emerged as a hot topic in company boardrooms – but activist managers have approached the subject from a decidedly different angle. 

“ESG is a growing topic in many boardrooms, but activist hedge funds aren’t focused so much on the ‘E’ (environmental) and ‘S’ (social). They like to use the ‘G’ (governance) as a way to attack incumbent boards in a campaign – but this is often a smoke screen for their ultimate goals: hedge funds are in for the profits, everything else is less relevant.”

Allocator appetite

Looking ahead, wider uncertainties underpinning the macroeconomic outlook have emerged as a major driver of a key investment theme in the shareholder activist scene – that of ‘self-help’ within companies.  

Hufnagel says: “Broadly speaking, we don’t really expect a significant economic improvement in growth that would make it much easier for everybody to do business. So instead we believe self-help is more relevant – this approach of finding companies who could do more to improve, or ‘self help’, their business.”

He continues: “Companies generally will need to work a little harder, and so those who don’t are more of a target for us. Against that background obviously we expect to find more opportunities, more angles, to come in as activist investors. That’s a perfect environment for us – we have no problem with an environment with a little less economic growth which is becoming more demanding for management teams.

“We invest fundamentally, focusing on companies that are decent but could be doing better. That’s really the catalyst for us.”

Talk turns to investor sentiment, with Hufnagel explaining how allocator appetite has steadily evolved in recent years.

“We’re talking about activist investing in core Europe, which means fundamental, deep value-type investments with an approach to changing things. Therefore, the investor needs to be comfortable with Europe, with value, because the US has been trading at multi-year highs compared to Europe, growth is trading at all-time highs over value, and public markets are trading at an all-time low versus private equity.

“That’s been a challenge when it comes to attracting North American investors. For us, the core investor base has been continental Europe, but this is changing significantly with more US investors. Their appetite has been increasing tremendously, and obviously performance has helped to keep that appetite not only alive, but to grow it.”

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