Activist hedge funds catch eye of institutional investors

Activist hedge funds pulled in at least $2 billion in new assets from institutional investors over the past two years, with a marked acceleration in pace in the second half of 2011 and so far in 2012.

In many cases, institutional investors are using traditional long-only equity assets — rather than dedicated hedge fund allocations — to fund big-ticket mandates to equity hedge funds that focus on pushing for operational changes in public companies in order to increase shareholder value.

The swell of assets from institutional investors has been so significant in the past year that two prominent activist hedge funds recently closed their strategies to new investors, industry sources said. ValueAct Capital Management LP capped its activist strategy at $8 billion, and Starboard Value LP is holding its small-cap-oriented strategy at $1 billion.

Among the large institutional investors in activist hedge funds:

• The Florida State Board of Administration, Tallahassee, which oversees $156.8 billion in pension and other state assets, started building an activist hedge fund portfolio in 2010, which now includes four funds managing about $550 million. The most recent investment was a $125 million allocation in May 2011 to Starboard Value & Opportunity Fund.


• The New Jersey Division of Investment, Trenton, which oversees the state's $70.5 billion in pension assets, has a total of $575 million invested with four activist hedge funds, most recently allocating $150 million in January to Cevian Capital II.


• The $140.3 billion New York State Common Retirement Fund, Albany, late last year committed $200 million each to Cevian Capital II, Trian Partners Strategic Investment Fund and ValueAct Capital Partners II.


• The Virginia Retirement System, Richmond, this month committed $250 million to Cevian Capital II from the $53.6 billion state pension fund.

For institutional investors, especially public pension funds, the allure of activist hedge funds is their strong, uncorrelated equity returns, Stephen L. Nesbitt, CEO of alternative investment consultant Cliffwater LLC, Marina del Rey, Calif., said in an e-mailed response to questions.

The average annualized return for the five years ended Dec. 31 for a group of eight unnamed activist hedge funds that are of institutional quality was 8.6% with aggregate risk of 13.8%according to Cliffwater's analysis. This compares to a return of 0% for the Russell 3000 index with a risk level of 19.6%, and a 1.8% return for the Morgan Stanley Capital International All Country World index with a 21.2% level of risk during the same time period.

“Some investors are opting to replace some of their traditional active equity managers with activist hedge funds that are not afraid to make big, concentrated bets and to emphasize a hands-on, value-added approach,” Joseph Larucci, partner at alternative investment consultant Aksia LLC, New York, said in an interview.

Because most activist hedge fund managers are generally classified as long/short equity managers, but tend to be net long and to rarely short securities, institutional investors are readily inclined to “place these managers in the long-only equity allocation, where traditional alpha has been scarce,” agreed Mr. Nesbitt in his e-mail.

Institutional investors favor activist managers like Starboard Value, ValueAct, Cevian Capital Ltd. and Trian Fund Management LP that generally work behind the scenes with corporate management to effect positive changes.

Some activist firms are more aggressive, including Pershing Square Capital Management LP and Third Point LLC, whose iconic CEOs William A. Ackman and Daniel S. Loeb, respectively, are not shy about waging their battles in the public eye. They also manage money for institutional clients, including the New Jersey Division of Investment. But according to publicly reported hires, the sizes of their institutional mandates tend to be smaller than those awarded to activists with a more subtle approach. Neither Mr. Ackman nor Mr. Loeb responded to requests for interviews.

JANA Partners LLC, New York, has had good luck taking a more collaborative approach with corporate boards, said Barry Rosenstein, JANA's managing partner and co-founder.

JANA's flagship hedge fund strategy is event-driven, but includes up to 25% or 30% of exposure to activist plays. The activist strategy also is available as a stand-alone fund with a three-year lockup and a private equity drawdown structure.

JANA's activist strategy takes concentrated bets on undervalued companies where the investment team has high conviction that their actions can trigger a catalyst that will “close the gap between fair value and what the stock is trading at when we acquire it. We control our own outcome and are not dependent on the good will of the market to increase shareholder value,” Mr. Rosenstein said.

“We've conducted 40 activist campaigns over the past 11 years, and we prefer to work cooperatively with management,” Mr. Rosenstein said. “The outcome will be the same if they fight us and because nobody benefits from a fight, when we show up, the conversation tends to become more constructive.”

The firm has $3.5 billion under management and in commitments, primarily from institutional investors.

Paulson & Co. Inc., New York, an event-driven and merger arbitrage specialist, also has had success over the years with occasional “constructive activist” campaigns, said John Paulson, founder and president.

In late March, Hartford Financial Services Group Inc. agreed with the hedge fund manager's recommendation to sell non-core business units to focus on property and casualty insurance, group benefits and mutual funds. Paulson & Co. is the insurer's biggest shareholder and worked with the firm to improve its share price (Pensions & Invest-ments, March 21).

“I would say that our overwhelming preference is to work constructively with management to improve shareholder value. You have a choice. You can always just sell the stock if you see too much recalcitrance from management, but we had an open and collaborative dialogue with Hartford's management,” Mr. Paulson said.

Paulson & Co. manages $22.4 billion for institutional and other investors.

Other corporate campaigns that Paulson & Co. and other activist hedge funds wage can often take years to bear fruit, a fact that makes them especially well-suited for institutional investors with long-term horizons, said Harlan Zimmerman, senior partner based in the London office of Cevian Capital.

“A lot of the interest we've seen of late from institutional investors is driven by their realization that most investors — and by that I mean money managers — are becoming more and more short term in focus. Volatility means predicting what markets will do is getting harder,” Mr. Zimmerman said.

“But endowments, foundations and pension funds are in a good position to invest with hedge funds like ours that practice horizon arbitrage, where as activists we focus on long-term value. When the whole world is moving in one direction based on short-term motivations, there is greater and greater opportunity to capture alpha by being much more long term in our approach,” he added.

Cevian Capital manages $6 billion for institutional investors in activist strategies.