More Hedge Funds Take Up the Activist Playbook

The struggles of the hedge fund industry have been no secret, and the funds continue to underperform the stock market while charging investors high fees for the privilege. With the Standard & Poor’s 500-stock index gaining in all but four of the past 24 months, it’s been difficult to evaluate whether hedge funds offer superior returns in bear markets, as their (possibly dwindling) supporters claim. There’s just been a drumbeat of pathetic results.

One area that’s been somewhat of an exception is activist hedge funds—those that buy a stake in a company and then agitate for such changes as acquisitions, board shakeups, or returning cash to shareholders. Activist funds get attention because getting attention is a huge part of the strategy. These battles are fought in large part with publicity, starting with high-profile conferences that bring hedge fund managers out on stage like rock stars. Managers such as Pershing Square’s Bill Ackman and Greenlight’s David Einhorn can be found often on CNBC and Bloomberg TV, talking up their positions.

The strategy is spreading. A new report (pdf) from research firm Preqin finds that 28 activist hedge funds were launched in 2013, up from 12 in 2012 and the most since 2007. The activist strategy returned 11.8 percent, on average, last year, Preqin said, beating 7.9 percent returns for all hedge funds. (Remember: The S&P 500 returned 32.4 percent in 2013, including dividends.) Activist funds have also delivered better returns over two, three, and five-year periods.

Charlie Munger, the longtime No. 2 to Warren Buffett at Berkshire Hathaway, said at the company’s annual meeting last month that activist investing has caused more commotion “than anything has in years. I don’t think it’s good for America.” The worry is that activist plays generate short-term gains in share price that don’t create any lasting value.

Munger must not have read the issue of Bloomberg Businessweek from early April, in which Tara Lachapelle and Beth Jinks wrote that activism can be good for the shareholders of a targeted company, with a 48 percent average gain—17 points better than the S&P 500, between 2009 and 2013. Activism can create big paydays, such as Starboard Value’s 215 percent win on AOL, as well as massive losses such as Ackman’s 71 47 percent loss on J.C. Penney. (Both numbers are as of Dec. 31.) [Correction: While J.C. Penney shares fell 71 percent between Ackman's original purchase and Dec. 31, 2013, he sold his stake in August 2013, for a loss of 47 percent.]

One risk facing activism is that its popularity could become its undoing: The strategy could become as crowded as the hedge fund industry overall, with more funds chasing the same number of opportunities.

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