Another accusation is that activist strategies can cut back aggregate employment levels in companies, since an obvious method of improving the profitability of a business is curtailing the number of staff. Here, solid evidence of the effect of activists’ actions on the workforce has not been found, Liem writes.
Finally, critics sometimes claim that hedge fund activism is really just bullying. That activist funds ‘sell out on the hype and leave the company to grapple with its own problems’ is a common accusation. In the aftermath of Deutsche Börse’s attempt to merge with the London Stock Exchange in 2005, which was scuppered by TCI’s Hohn, the German finance ministry appealed to market regulators to place restrictions on “short-term profit-oriented foreign investors”.
But stoic opposition from the US, which favours a market-based approach to regulation, resulted in Germany relinquishing its attempts at regulatory change.
Power in numbers
“There are more activist managers out there than you think,” says Kevin Wan Lum, a portfolio manager with Liddell’s team at QIC. Mercer IC estimates that at the end of calendar 2006, there were between 100 and 120 activist hedge funds globally, collectively holding about US$50 billion in funds under management.
Although these funds account for a sliver of the US$1.8 trillion hedge fund industry, the rise in their number is significant, given that they have influence and that, five years ago, there were about 40 of them. “They often have the ear of major institutional investors,” Liem writes, “and this may lead to the demise of a prominent CEO if they appear to have lost their golden halo.” While big institutions are capable of shareholder activism, these tasks may be best left to hedge funds.
They are less constrained than institutions, Liem writes, having the ability to own more than 10 per cent of the outstanding securities of any company. Given their remuneration arrangements enable them to take a slice of outperformance, they can personally benefit from activism, unlike mutual fund managers. And the lock-up conditions on investors’ capital set by some hedge funds allow them to build long-term positions.
According to Liem, “the available empirical evidence indicates that compared to traditional institutional investors engaged in activism, activist hedge funds are particularly effective”. Their effectiveness can be heightened if managers band together with a common target in sight. “The new activists often band together and swarm all over management,” Liem writes.