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The evolution of activism

Mark Shaw, Portfolio Manager

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Q1 2014

Open any business newspaper and you are almost guaranteed to see at least one reference, if not more, to an activist investor engagement. This style of equity investing has returned to the fore and today has become more established, better known, and is better understood as a benefit to shareholders. Engagements have advanced from an occasional threat to corporate management to becoming an indelible feature on the investing landscape that every company board needs to be aware of.  This situation has both strengthened corporate governance practices and raised the accountability stakes. Because of this, one of the greatest shifts that we have also observed in recent years has been the increased support that activists are able to gather from more traditional investors who far better understand the benefits of having engaged shareholders. Furthermore, adding to the activists’ profile are some impressive long-term returns.

As things stand, from a corporate perspective, while a number of companies have already taken proactive steps to improve their operations and there has been a significant uptick in corporate governance standards, there are still large numbers of companies sitting on their hands.  Too many are maintaining their old fashioned standoffish and often lackadaisical corporate attitudes, so questions can quite rightly be asked by shareholders, although often it may take an activist manager to make the first move.  This remains a very deep pool of opportunity for the activists and as a result we believe that there are likely to many more engagements going forward, particularly as it is harder for boards to so easily dismiss shareholder concerns.

This level of accountability and scrutiny is not just reserved for the small cap companies – arguably easier targets – but across the whole range of caps, with behemoths such as Sony and Apple also under the microscope, and this has been reflected in the following numbers: According to Citi research, in 2009 seven campaigns targeted companies with market values of more than $10 billion and by 2012 this figure had increased to 20.  Last year, activists pressed for change at some of the largest and most established listed companies in the world and while many of these situations were in the public domain, many more have been agitating behind the scenes. 

In today’s market a great deal of the activists’ focus is on corporate balances sheets, with large numbers of companies operating far too conservatively. What is clear is that companies hoard cash on their balance sheets – RBS reported a figure of £754 billion on UK corporate balance sheets and in the US this figure is ~$1.5 trillion in non-financial S&P 500 companies – this is a highly inefficient use of cash given the exceptionally low interest rates. Instead, activists believe quite rightly that it is in shareholders’ interest to either return this cash to shareholders, utilise the low rates to alter the mix of financing, or take the opportunity to look at new ways to develop the company. 

Many companies are also either over-investing in areas that are unproductive or under-investing in profitable areas of a business, a weakness that can be found across companies of all sizes. This was certainly the case at Heinz, which had a disperse marketing spend across all its brands, rather than a focus on core profitable brands.  In such situations, the aim of the activist is to refocus a company on what it does best, strengthen operations and sales and/or reduce costs, actions that are designed to ultimately increase the share price. Not surprisingly large conglomerates are particularly exposed to such activist approaches and many do trade at a discount to the sum-of-their-parts. Where this is the case, the company’s management and board really should review alternative strategies and structures. This is a key reason why we have seen a number of spin-offs in recent times, notably McGraw-Hill, which at the prompting of an activist investor spun-off its education division.

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There is a common misconception about activists being short-term in their investment horizon.  But really this is not the case, for as a rule activist investors tend to be invested for the long-term with multi-year time horizons. This is in contrast with the average fund manager who has shortened their investment horizon to quarters if not weeks. What's more, when an activist exits their investment there is little evidence of 'abnormal long-term negative returns' (source: The Long Term Effects of Hedge Fund Activism, Lucian Bebchuk, Alon Brav and Wei Jiang - July 2013).

Generally speaking, attitudes towards activists have evolved, although this is not the case across every market.  In the UK and in particularly the US, where the bulk of current activists are based, the markets are better suited to this style of engaged investment management.  Partly what makes these markets standout - relative to other regions – is the high degree of transparency as well as the involvement of institutional shareholders, who today can often be found siding with an activist investor.

Activists operate in Asia and continental Europe, but these tend to be more difficult markets, and they are few and far between. This is partly because of a different emphasis on shareholders versus other stakeholders, such as employment stability, but also the complexity of some of the cross-shareholding structures.  The result tends to be a less confrontational approach, with managers operating more quietly in the background.

Without doubt, activism has taken giant strides forward in recent years and today is firmly an established part of the investment landscape.  This has been reflected in the growth of sector assets, which have gone from $32 billion in 2008 to $93 billion in Q4 2013 (source: HFR). Activists are taking a long-term approach and seek to maximise a company's potential, actions that ultimately are a benefit to shareholders. With a market environment that remains conducive to this style of investing and no company out of reach, we believe that these investors are set to continue delivering significant shareholder value going forward.

The views expressed in this article are the employee's as of the date stated, are subject to change and do not necessarily represent the firm's opinion.

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