Published on December 7, 2023
Activist Funds: A Smart Strategy for Returns in Volatile Markets
This insight provides a closer look at activist funds, how they work, and why they may be a smart choice for returns during the ongoing bond yield crisis.
What Are Activist Funds and How Do They Drive Changes at Target Companies?
Activist funds are a type of hedge fund that seeks to increase the value of the companies they invest in by actively engaging with management teams and boards of directors. They use their ownership stakes to advocate for changes that enhance the target company’s performance. They do this by engaging with management teams and board directors to influence company strategy and operations. Unlike passive investors, activist funds use their ownership stakes to agitate for changes that they believe will improve the target company’s performance.
There are two main types of activism: long and short.
Long activism, exemplified by activists like Bill Ackman of Pershing Square or Jeff Ubben of Inclusive Capital, focuses more on enacting change through engagement. This could involve nominating new board members, advocating for a sale of the company, pushing for higher dividends or stock buybacks, and banding together with other investors to gain voting power and sway. The overarching goal is to address issues holding the company back and help it reach its full potential value.
Short activism centers on uncovering fraud and mismanagement, often leading to a decrease in the company’s stock price. This form of activism, employed by firms like Hindenburg Research, Muddy Waters, and Citron Research, involves thorough investigation and public reporting of fraudulent practices or mismanagement within target companies. While the tactics differ, both long and short activism aims to correct discrepancies between a company’s current operations and its potential value.
Activist funds differ from private equity funds in that they typically don’t seek full control of the companies they invest in. Instead, they aim to work collaboratively with management while leveraging their minority stake and shareholder rights to enact change. Top activist funds include Starboard Value, DNP Capital, and Third Point.
Activist hedge funds use a variety of tactics to engage with target firms and advocate for change. These include:
- Waging proxy contests to gain board seats: Activists nominate director candidates that support their agenda and urge shareholders to vote for them. Gaining board representation is a powerful way to advance desired changes.
- Publicly advocating for strategic changes: Activists make their case for operational improvements, divestitures, leadership changes, dividends, and more through open letters and presentations. This public pressure makes it dficult for management teams to ignore activists’ demands.
- Lobbying regulators and lawmakers: Activists leverage regulatory filings and lobbying to promote their objectives where applicable.
- Litigation: Lawsuits or the threat of legal action are used at times to bring management to the negotiating table.
- Banding together with other investors: Activists frequently build coalitions with other shareholders to gain voting power and sway.
These techniques are intended to compel management teams to embrace activists’ proposed changes. Even minority stakes can wield influence when combined with thoughtful strategy and shareholder advocacy.
Activist Funds Outperform Russell 3000
In the face of rapidly rising bond yields in 2023, many investors are seeking strategies to generate returns without excessive risk. Activist funds, which take substantial stakes in undervalued companies and advocate for changes to unlock shareholder value, present an attractive option in this volatile environment.
As the chart “A portfolio of activist targets has outperformed the broader U.S. stock market” illustrates below, investments in activist targets have generally yielded higher returns compared to the broader U.S. stock market, especially notable after 2020. This performance is measured by the indexed performance of an equal investment in every activist target the day a campaign is launched versus Russell 3000 from 2006 to 2024.
A Portfolio of Activist Targets Has Outperformed the Broader U.S. Stock Market Indexed performance of equal investment in every activist target the day a campaign is launched vs. Russell 3000
Why Can Activist Funds Outperform In a Rising Rate Environment?
One possible reason activist funds can outperform in a rising rate environment is that they target companies that are undervalued, underperforming, or have governance issues that can be improved by shareholder intervention. In a rising rate environment, where borrowing costs increase and growth prospects diminish, activist funds can benefit from their ability to create value through operational and financial improvements rather than relying on macroeconomic factors or market sentiment. Activist funds often seek to unlock value by pushing for changes in the target companies' board, management, strategy, or capital structure. By doing so, they can increase the companies' profitability, efficiency, and competitiveness and enhance their shareholder returns.
Successful Activist Funds Case Studies
These examples illustrate how activist funds can generate superior returns by identifying and unlocking value in companies that are underappreciated or mismanaged by the market.
ValueAct Capital: Founded by Jeffrey Ubben in 2000, ValueAct is an activist fund that takes large stakes in companies and works constructively with management and boards to enhance long-term value. ValueAct focuses on companies that are fundamentally undervalued but have strong business models and growth potential. ValueAct often seeks board representation or observer rights at its target companies and avoids public confrontations or proxy fights. In 2022, ValueAct launched a campaign at Citigroup, a global bank that had struggled with low returns and high costs. ValueAct proposed a plan to improve Citigroup's performance, which included simplifying its business mix, optimizing its capital allocation, streamlining its operations, and enhancing its digital capabilities. As a result of ValueAct's pressure, Citigroup agreed to grant ValueAct access to confidential information and board members and to consider ValueAct's suggestions for improving shareholder value.
Trian Partners: Founded by Nelson Peltz, Peter May, and Ed Garden in 2005, Trian is an activist fund that invests in underperforming companies with strong franchises and attractive growth prospects. Trian aims to work collaboratively with management and boards to implement operational and strategic improvements that can generate long-term value. Trian often nominates directors to the boards of its target companies and sometimes takes an executive role as well. In 2022, Trian launched a campaign at Invesco, an asset management firm that had suffered from net outflows and lagging stock performance. Trian argued that Invesco had failed to capitalize on its acquisition of OppenheimerFunds and needed to cut costs, improve margins, and increase scale. Trian also pushed Invesco to merge with another asset manager, such as Janus Henderson or Eaton Vance. As a result of Trian's pressure, Invesco agreed to appoint Nelson Peltz and Ed Garden to its board and explore strategic alternatives for enhancing shareholder value.
Starboard Value: An activist fund specializing in technology and consumer sectors. In 2022, Starboard targeted eBay, an online marketplace that had lagged behind its competitors in growth and innovation. Starboard criticized eBay for its poor execution, excessive spending, and lack of strategic vision. Starboard urged eBay to sell or spin off its non-core businesses, such as StubHub and Classifieds, and to focus on improving its core marketplace platform. Starboard also nominated four directors to eBay's board to oversee the changes. In response to Starboard's pressure, eBay agreed to sell StubHub for $4 billion, explore strategic alternatives for Classifieds, cut costs by $2 billion, and increase its dividends and buybacks. These moves lifted eBay's stock price by more than 40% in 2022, outperforming the Nasdaq Composite index by 15%.
What Are The Benefits of Activist Funds In Today's Market?
Activist funds are investment funds that seek to influence the management or strategy of underperforming companies. They can offer several advantages for investors in today’s challenging market conditions. Some of these benefits are:
- Strong Returns: Activist funds aim to unlock the hidden value in target companies by proposing changes such as operational improvements, strategic shifts, capital allocation, or governance reforms. These changes can boost the company’s performance and profitability, leading to higher investor returns. For example, a study by J.P. Morgan found that activist funds outperformed the S&P 500 by an annualized 16% from 2001 to 2011.
- Risk Diversification: Activist funds rely on company-specific factors rather than market trends to generate returns. This means that their returns are less correlated with the broader equity markets, which can reduce portfolio risk and volatility. According to a report by Credit Suisse, activist funds had a correlation of 0.77 with the MSCI World Index from 2009 to 2018, compared to 0.91 for global hedge funds.
- Inflation Hedge: Activist funds tend to target companies that have strong cash flows and low debt levels, which can provide a hedge against inflation. Cash can be used to increase shareholder value through dividends, share buybacks, or reinvestments. Alternatively, cash can be deployed to acquire other companies or assets at attractive prices.
- Shorter Time Horizon: Activist funds have a shorter investment horizon than private equity funds, which can take years to realize returns. Activist funds typically seek to implement changes within 12 to 18 months, which can suit the fast-paced and dynamic nature of today’s markets. Moreover, activist funds can exit their positions more easily than private equity funds, as they invest in publicly traded equities with higher liquidity.
- Transparency and Liquidity: Activist funds offer more transparency and liquidity than private equity funds, as they invest in public equities subject to disclosure and regulatory requirements. Investors can access activist strategies through various vehicles, such as hedge funds, mutual funds, and exchange-traded funds (ETFs). For example, the Global X Guru Activist Index ETF (ACTX) tracks the performance of 50 U.S.-listed companies that are targeted by activist investors.
In summary, activist funds can provide attractive opportunities for investors looking for strong returns, risk diversification, inflation hedge, shorter time horizon, and transparency and liquidity in today’s market environment. However, investors should also be aware of the potential risks and challenges associated with activist investing, such as shareholder resistance, legal disputes, reputational damage, and execution risk. Therefore, investors should carefully evaluate the activist fund managers' track record, strategy, and alignment of interests before investing.
- Harvard Law School Forum on Corporate Governance, July 18, 2023. “Shareholder Activism: What Investors Seek, Which Companies Are Targeted, and How Stocks Perform.”
- Goldman Sachs, April 20, 2023. “Shareholder activism: What investors seek, which companies are targeted, and how stocks perform.”
- Harvard Law School Forum on Corporate Governance, July 18, 2023. “H12023 Review of Shareholder Activism.”