In one of the most intriguing articles I’ve read in a long time, The Economist’s Capitalism’s unlikely heroes suggests a different perspective on the rise of activist hedge-fund investors. These brash and vocal billionaires take small positions in public companies and act to fix mismanagement by trying to convince other shareholders to support cost-cutting, spin-offs, and returning cash to shareholders.
Unlike buy-out private equity, the activist hedge funds buy only a small amount of shares, and so they neither burden the target with loads of debt nor strip companies of their assets (that’s so 1980s). Unlike Wall Street investors, activists get actively involved in management decisions. Naturally, companies’ chiefs abhor them. Critics call them vultures. Boards try to poison-pill them.
More interesting than the acrimony between companies’ top executives and tormentors like Bill Ackerman and Dan Loeb is the phenomenal rise in the level of activity of these activists’ funds. According to The Economist, they’ve got $100 billion in their war chests (about 20% of all hedge-fund capital inflows in 2014). Last year they launched 344 campaigns against public companies including P&G, Apple, Microsoft, Pepsi, and even Netflix. As shocking as it may sound, one out of two companies on the S&P 500 index has shown an activist shareholder on its stock registry in the past five years.
Why is there such an increase in activists’ funds? Have companies gotten worse and caused an immune response?
Companies gone wrong
Well, yes. The reason, suggests The Economist, is that investors have become lazy. A lot of investment in stocks is either index funds or exchange funds. Such funds track performance passively, dumping stocks by computer algorithm. Mutual funds don’t get involved in governance. Pension funds may take up a cause like divesting companies that harm the checkered ant in the Peruvian forest but they don’t try to improve rotten management. And, as The Economist says dryly, “plenty of companies suffer from rotten management.”
The data show activist involvement increases investment in R&D, raises capital expenditures, and improves profit. Not just short-term profit. Long-term, too.
Cozy and insular, fat and temporarily happy
Activists’ funds are a significant development in the race to make public companies more competitive. The fundamental advantage these activists bring is an external perspective. If management’s perspective were so great, activists’ would have no way to increase long-term profit.
We take for granted that executives know how to compete effectively. That’s how they got to be executives, isn’t it? The results from activist investors suggest otherwise.
So does this. Competing as a skill requires constant vigilance and external focus. A recent survey reports management’s tendency to isolate itself from uncomfortable views. In this survey of CEOs’ activities on social media, less than 40% of subordinates described their CEOs as good listeners or as competitive. While I don’t know whether activist investors are more or less keen to target companies run by bad listeners, let me pose it as a testable hypothesis. It surely makes sense.
If you are an executive, perhaps getting your activist investor to head a competitor team in a war game or simulation may be more profitable than calling him a scumbag.