Activist managers get more flies with honey
More subtle approaches are attracting the attention of institutional investors
By Christine Williamson | June 12, 2006
The infamous Daniel S. Loeb is sheathing his claws — just a little — as he pursues his particular brand of hedge fund activism, a move likely to make the firm he founded, Third Point LLC, palatable to a growing institutional investor base.
Intrigued by five-year annualized returns more than double those of the average long-short equity hedge fund, institutional investors are looking seriously at activist funds like Third Point and its brethren, consultants and hedge fund managers said. Institutional interest is strengthening to the point that at least two activist hedge funds of funds will launch before the end of the year while other managers are contemplating starting similar funds, sources said.
Some institutional investors have or soon will get exposure to activist hedge funds, as consultants said many of the multistrategy and hedge funds of funds used by their institutional clients are adding them to their portfolios. For example, in the March 31 annual report of the BNY/Ivy Multi-Strategy Fund LLC, institutional hedge fund-of-funds manager Ivy Asset Management Corp., Garden City, N.Y., listed several activist funds among its portfolio holdings, including the Deephaven Event Fund LLC and Stark Investments LP.
Mr. Loeb's previous tactics ranged from scathing written criticisms of company managements to all-out public warfare with recalcitrant boards.
Sources said these were exactly the kind of activities most likely to alarm institutional investors sensitive to the political and public relations implications of union job cuts, factory closings, overseas job outsourcing and other changes often demanded, loudly and publicly, by the more antagonistic hedge fund activists.
Kinder, gentler approach
Mr. Loeb, founder and chief executive officer of the $4 billion New York-based hedge fund, is taking a kinder, gentler approach lately in his letters to company managements and in filings. Mr. Loeb would not comment, but a source close to Third Point said the firm's investment strategy has changed, now that it is larger and much better-known.
"Now that Third Point is bigger and can buy more shares in order to be more effective and can get candidates elected to corporate boards and that sort of thing, Dan doesn't have to use his old tactics. The investment team is going about implementing the strategy differently than they did when Third Point was a younger firm," said the source, who requested anonymity. The source also pointed out that just 5% of Mr. Loeb's assets are invested using activist strategies, although he is best-known for his activities in this area.
In other words, Mr. Loeb is acting a lot more like an institutional activist shareholder. So much so, in fact, that independent proxy researcher Institutional Shareholder Services, Washington, strongly recommended that shareholders support Mr. Loeb's proxy bid for a seat on the board of coal mining company Massey Energy Co., Richmond, Va.
Final results of Massey's May 16 annual meeting have not been announced, but the company confirmed that Mr. Loeb received enough votes to gain a seat on its board. On May 22, Massey also announced a buyback of up to $760 million of its outstanding shares, one of Mr. Loeb's other recommendations for increasing share value.
The growing awareness by institutional investors of synergies between the shareholder activism pension fund officials already do with their long-only equity portfolios and that of hedge fund activists is another strong driver in the nascent institutional investment trend of activist hedge funds, said sources.
"The trend is for more pension plans, especially state plans, to realize that they are significant owners of equity in their long-only portfolios. But the more subtle realization is dawning on (officials at) some of these plans that their corporate governance activism could be very synergistic with activist hedge funds," said Dean S. Rubino, managing director and director of manager research at Richcourt Group Inc., New York. Richcourt manages about $1.2 billion in hedge funds of funds for institutions.
But it's performance that has other investors joining the ranks of institutions like the $204.4 billion California Public Employees' Retirement System, Sacramento, and the $5.2 billion endowment of Yale University, New Haven, Conn., which already invest in activist hedge funds. Brad Pacheco, CalPERS spokesman, did not provide information about the total invested in activist hedge funds, but confirmed that the plan allocated $200 million to activist Steven B. Klinsky, managing director and chief executive officer, New Mountain Capital LLC, New York. Officials at Yale did not return a call seeking information, but recent press reports said the endowment had until recently invested $500 million with hedge fund activist Christopher Hohn, managing partner, The Children's Investment Fund Management (U.K.) LLP, London.
"Interest in activist strategies has been escalating and investment is popping up everywhere. Right now, among hedge fund strategies, activist funds are doing very well. They're hot," said Stephen L. Nesbitt, chief executive officer of alternative investment consultant Cliffwater LLC, Marina del Rey, Calif.
For example, the activist hedge funds that Cliffwater tracks had an average annualized return of 18.6% for the five years ended March 31, compared with 9.4% for long-short equity funds in the Hedge Fund Research Inc. HFRI index for the same time period. "Institutional investors are realizing they can make money by investing with activist hedge funds," in a more tangible way than they can with traditional activism activities, Mr. Nesbitt said.
"Institutional investors are staying pretty quiet about it, but they are interested in the returns generated by many activist hedge funds, and some have already invested. But they are not likely to invest in the so-called ‘churn and burn' hedge fund activists who move rapidly in and out of companies," to make a quick buck, said Karen Sampson, director of hedge funds at Greenwich Associates Inc., a Greenwich, Conn.-based institutional financial services consultant and researcher.
"Institutional investors will look for activist hedge funds that mirror their own values as a shareholder."
And for their part, activist hedge funds are finding that institutional clients may be a more lucrative, stable source of capital than they once thought.
In particular, Messrs. Nesbitt and Rubino said activist hedge funds likely will employ a co-investment model when they need capital for a particular activist situation, similar to a private equity model that puts out a call to funds to fund their commitments because they've found a deal to invest in. Mr. Nesbitt said having more existing institutional investors will permit hedge fund managers to raise assets quickly if they need to snap up more shares to increase their influence with a particular target company.
Detailed information about the most successful activist hedge funds is scant, "because the most constructive hedge fund activism does not happen in the public eye," said Barry F. Cronin, managing director, partner and portfolio manager, Taylor Cos., Greenwich, Conn. "Sound, constructive, behind-the-scenes advice from hedge funds helps companies to make sound capital allocation decisions over the medium term. If the company implements the recommendations, the company may gain value and all shareholders will benefit."
The most successful hedge fund activists are "exceptional stock pickers," Mr. Cronin said. "They are the equity sharpshooters who have the skills to find undervalued situations and then help identify a catalyst that will change the value of the company."
Taylor Cos., a hedge fund-of-funds manager, launched a fund of funds in January that invests in managers who may take an activist approach. Mr. Cronin said the fund is starting to attract attention from institutions and family offices. He declined to say how much the firm manages in total.
Richcourt likely will launch a concentrated-position activist hedge fund of funds later this year in response to interest from clients. Hedge fund-of-funds manager Pine Grove Associates Inc., Summit, N.J., also will introduce a concentrated activist multimanager vehicle July 1, said a source who requested anonymity.
Gwenn Daniels, a Pine Grove spokeswoman, declined to comment.