A rallying cry at superannuation conferences is for sharper shareholder engagement with investee companies, aimed at unlocking more value for members. But strangely, the investment managers dedicated to this pursuit – activists – are largely absent from the domestic market. This is despite the wealth of underperforming target companies, and the good track record established by overseas activists in generating absolute returns by galvanising shareholder campaigns. SIMON MUMME reports.
For an industry pushing for better shareholder returns and corporate governance from portfolio companies, the lack of pressure from Australian super funds and their investment managers on businesses is striking. A clear indicator of an investment industry serious about catalysing better returns and corporate governance from companies would be the presence of strong activist funds backed by institutions. Investors know that corporations do not always act in the best interests of shareholders, and that shareholders are often kept powerless by barriers to collective action, conflicts of interest and reluctance to face the public glare of legal action. Activist managers, with large shareholdings and an understanding of legal and corporate governance methodology, bring the heads of companies into contact with their shareholders.
The success of offshore activists Laxey Partners, Weiss and Carousel Capital in local listed funds throughout 2008 shone a light on the low-hanging fruit in corporate Australia available to investors with the ability to unlock value from underperforming businesses, says Stephen Mayne, business journalist and shareholder activist. “I’m still amazed there is not an Australia-based activist fund of scale, considering the big profits made by large offshore funds,” Mayne says. “The culture of Australian managers is largely to sell rather than roll up their sleeves and do some work. There is a culture of ‘don’t rock the boat,’ extending from the retail industry, to elements of the media and right through to institutions that amounts to a prevailing endorsement of the status quo.” Was it the long equity bull market that satisfied institutional investors with traditional investment strategies, or is it the lack of established activist investors in Australia that prevents institutions from allocating to the high-conviction, hands-on managers?
In a 2008 research note, Mercer Investment Consulting pointed to studies outlining the consistent, long-term outperformance of activist hedge funds in the US. One study, by April Klein and Emmanuel Zur, which studied 194 Securities and Exchange Commission 13D filings, found that activists’ target companies generated an average return 10.3 per cent ahead of untargeted companies between January 2003 and December 2005. Tony Cole, business leader for Mercer Investment Consulting in the Asia-Pacific region, says some traditional managers, such as Peter Morgan of 452 Capital, Elizabeth Bryan (formerly State Super and now chair of UniSuper’s investment committee) and Paul Fiani of Integrity Investment Management, have engaged companies on behalf of investors to remedy bad corporate behaviour. But he also sees the value that activist managers have delivered to institutional investors in the US and European markets.
“Looking at the performance of activist managers convinced me that over time these people were able to enhance investor returns, and were doing everybody a favour by focusing on the worst areas of corporate governance and fixing them not only for institutions but for the general investment public,” Cole says. “It would be good to see some activist fund managers operating in Australia.” The profits reaped by Carousel and Weiss through their greenmailing (agitating for a preferential exit) of the LinQ Resources Fund showed the opportunities a domestic activist fund could exploit. In April, Sydney boutique manager Sandon River Capital quietly launched what is understood to be Australia’s first dedicated activist fund. Managing director Gabriel Radzyminski says for a market of Australia’s size and sophistication, with regulatory laws giving more power to Australian investors than their US peers, activism is appropriate.
It deploys “buy and do” strategies that can provide a more clearly defined return expectation than traditional plays, which Radzyminski says are “very much buy and hope”. “There is this spate of underperforming companies that represent significant opportunities but also significant amounts of work.” An emerging manager, Sandon River looks for small and micro-cap companies whose share prices are trading far below what are perceived to be their intrinsic values, and targets them if a viable strategy to increase their market value is clearly visible. “If you can’t see a good strategy to effect change, it’s a value trap.” Some strategies are as basic as implementing more effective business or communications strategies. Others involve catalysing changes at the operational, strategic or board level. Most require the influence of other shareholders. “We won’t look at situations where a solution is only available to us.
We look at solutions that are good for all shareholders, because we won’t have a long-lived strategy if we’re seen as being only out there for ourselves.” This rationale screens out any greenmailing tactics that only reward activists with a favourable payout and leave continuing investors with an underperforming asset. “The solution has to be available to everyone – like an equal access buyback, rather than a selective buy-back for ourselves.” The first hedge fund activists were corporate raiders who attacked companies, engineered asset sell-offs or greenmailed targets to snare a hefty payout. Hostile bids are still a valuable activist tool, but most contemporary managers drive changes to financial, strategic, corporate governance or operational direction from behind closed doors. Financial catalysts for change, such as share buybacks, special dividends or balance sheet restructurings, aim to improve the capital structure of targets and unlock more cash for shareholders.
But strategic campaigns – aimed at selling a company, divesting it of particular assets or changing its corporate strategy – have historically generated the biggest payoffs for activists, but also meet the most resistance from executives, whose usual tendency is to pursue growth at all costs. Cole says genuine activist managers have concentrated portfolios, holding between six and 10 targets. Their tracking error is high, and because they are catalysing change within companies, any payoffs will emerge over a long timeframe. “A genuine activist manager might take three or four years to turn a company around, and in the interim, there’s chaos at the company, so it can be a J-curve-type effect. “It’s a lot of trouble to invest a very small part of your fund – and if you do well it won’t make an enormous difference to your returns.” Activist strategies are typically implemented through private engagement, rather than “shouting through the newspapers” to publicly strike at companies, Cole says.
Mayne also supports engagement – a “tread softly but carry a big stick” approach – rather than hostile power struggles. “You should always engage, and encourage a company to move ultimately down a sensible road, because resolutions worth considering should come after a period of determined engagement. “I don’t telegraph my punches before an AGM [annual general meeting]. But I’m a retail investor and I’m trying to shine a light on situations. When you’re doing it as a substantial shareholder and trying to achieve a specific outcome, engagement is more effective given human nature and ego.” Getting active The major barrier to the growth of activist funds in the Australia institutional market is investors’ reluctance to embrace the strategy.
This is mainly because emerging activist managers can’t point to a substantial track record. “The biggest challenge is inertia,” Radzyminski says. Mayne says the reliance on a threeyear track record by institutional asset allocators and gatekeepers is unfortunate. “It’s a chicken-and-egg problem. They are unlikely to back a principal without a track record.” According to Cole, the story was different in the US, where emerging activist managers received seed capital from big pension funds, including the US$176 billion Californian Public Employees retirement System (CalPERS). “There are quite a lot of activist managers in the US, and you find that their history is tied to CalPERS, who was a cornerstone investor and nurtured them, and was a significant contributor to getting activist investors to work hard at improving the corporate governance at companies. “We haven’t had significant funds prepared to sponsor such a development.”
Mayne says the Future Fund and state government-backed managers Queensland Investment Corporation and Victorian Funds Management Corporation, none of which have supported local activist funds, have much to answer for: “you would think a Labor government would support the principle of holding companies to account”. The big retail funds managers, which run some of the country’s biggest funds, are constrained by commercial imperatives: they are owned by the big banks, whose clients would likely become targets for hedge fund activism. “The highly concentrated, almost inbred nature of the financial services industry is part of the problem.” Operating in the small-cap space, Sandon River is interested in engaging up to 60 target companies but the boutique has resources and capital to pursue only 15 at this stage.
Radzyminski founded the firm after running the funds management operation of a family office for a number of years – which involved managing highyield debt and listed and private equity assets. “This gave us a taste of being on the receiving end of poorly performing companies, and seeing opportunities where the only way to unlock value was by being an activist,” he says. While it seeks institutional backers, Sandon River also drives activist strategies on behalf of major shareholders in companies, and is speaking with smallcap portfolio managers to source opportunities for activism, and potentially collaborate on strategies.
Commenting on one persistent corporate governance problem at companies – the obscenely large pay packages for some corporate executives – Radzyminski says the incentives rewarding big pay packets, not the size of the payouts alone, should be overhauled. “While executive remuneration is a hot public debate, we don’t believe it’s the single worst thing. The vast majority of destroyed value isn’t the amount paid to people, but the perverse incentives created and bad strategic and tactical decisions,” he says. Pay structures that provide executives with reasonable base salaries and big bonuses for risky business moves created an asymmetry between management and shareholders, because the upside for executives is immense, and the downside limited, while the benefits from these big bets are comparatively small for shareholders. “There is more downside for shareholders if risks don’t pay off. But if they do, shareholders do okay, but managers do excessively well,” he says.