The “proactive alpha” of activist managers is different alpha to that pursued by other, more passive, investors, Liddell says. Rather than requiring the market to take a certain turn or present opportunities, “an activist goes into a company and creates value rather than extracts it,” Liddell says. Their ability to generate this value depends on their knowledge of markets and business, their networking skills and contacts in the corporate world, which sometimes include allies who can be called upon to become directors.
They are “very proprietary in what they regard as their intellectual property,” Liddell says, which includes keeping secret the timing of their investments in companies, to avoid being front-run by other investors. Mercer IC’s Liem believes that in the future many hedge funds will rely on their own resources and specialised capabilities to generate alpha. He observes that an activist manager’s specialised skill-sets and ability to network and build relationships will be increasingly valued as “pure alpha”. “It is likely that more and more hedge funds will trade no longer purely on the availability of public information but will rely instead on change management skills and strategic thinking.” In a world of hedge funds where statistical arbitrage models have become more common and zeroed in on a wider array of opportunities, spoiling the attractiveness of certain arbitrage strategies that operate in short timeframes, Liem believes that the case for activist hedge funds will become stronger. “Despite the increased competition and the late stage economic environment reducing the universe of potential opportunities, we consider it likely that hedge fund activism will gain more and more traction.”
Words will never hurt me
A successful activist will often gain control of the target firm’s agenda, increase its debt load, reduce the amount of cash on hand and pay out increased dividends to the shareholders. While the funds appear to be effective in executing their aims and “optimising the financial structure” of target companies, Liem writes, these same actions prompt criticism.
Among other claims, activist funds have been accused of weakening their targets by directing resources away from long-term corporate strategies designed to create value. However a 2006 academic study by Alon Brav, Wei Jiang, Randall Thomas and Frank Partnoy that examined 900 instances of hedge fund activism from 2001 to 2005 concluded that hedge funds act as both value investors and shareholder activists.
The study found that outperformance of 5 to 7 per cent observed in the weeks surrounding the incidents of activism showed no apparent reversion to previous performance in the following year. And, over the subsequent two years, the researchers found a discernible improvement in the operational performances of the targeted companies.