Activist Funds Excel at
Collecting Fees, Not Fixing Companies
Feb. 4, 2023 10:56 am ET / Original Feb. 3, 2023 1:14 pm ET
Proxy fights like the one between Trian and Salesforce grab
undue attention because “humans love to watch conflict,” says
one researcher. Here, Salesforce co-CEO Marc Benioff.
I’m thinking of launching an activist hedge fund that buys big stakes
in underperforming companies and demands their board seats. Not the
positions—the actual seats. “Everyone stands until the share price
doubles,” I’d tell directors in a vigorously leaked letter.
“Sincerely, Bottom Up Investment.” I’d charge the standard 2% a year
plus 20% of profits, and promise never to offer advice.
The statistical evidence suggests that Bottom Up could perform as well
as the greats, who, it turns out, aren’t that good. Activists in
general don’t seem to add much value to the companies they target
beyond an initial pop in the stock price. They also tend to earn
uninspiring returns for their own investors, after taking hefty fees.
What’s an activist? A corporate raider without the commitment. If
you’ve ever been to a Peewee basketball game and heard parents
coaching from the stands, picture one of them walking to the bench,
sitting down, grabbing the clipboard, and telling Silas to stop
chucking from the outside, Jasper to hit the boards, and Henry to go
turn his shorts right-side-out. The actual coach would probably
welcome that help as much as CEOs appreciate raiders and activists,
the two main types of high-finance buttinskys.
raider buys, say, 10% of shares outstanding and then makes a tender
offer to shareholders, usually at a premium price, to secure voting
control. With control, the raider can replace the board and hire,
fire, sell, merge, borrow, and change strategies at will. An activist,
on the other hand, typically buys 5% to 10% of shares and then tries
for board seats or operational changes without buying control. Step 1:
Ask nicely. Step 2: Put out a slide deck calling management bumblers
or self-servers, only with charts. Step 3: Try to convince other
shareholders to vote the board or managers out, called a proxy fight.
popular perception, raiders are short-termist villains, like
Gordon Gekko in Wall
Street, while activists are defenders of shareholders
against corporate squander and greed. Zohar Goshen, who teaches
corporate governance and securities regulation at Columbia Law School,
challenges this view. “Activists are no better than raiders; if
anything, they are likely worse,” he wrote in
a paper published in November in the Yale Law Journal.
comes down to what Goshen calls “mistargeting.” Raiders often pay 30%
to 50% of a company’s preraid stock market value just in their offered
price premium to win control. So they had better pick targets
carefully. But activist campaigns, not counting the initial outlay for
shares, are relatively cheap. One study put the average cost of one
ending in a proxy fight at $11 million. That makes it tempting to
target companies willy-nilly, raising the chances of misjudging.
Sometimes activists mistake patient companies for poorly run ones.
Carl Icahn pushed (ticker: NFLX) to sell itself in 2012 and
failed. The stock is up more than 3,500% since then. They
can also identify struggling companies and make things worse. Bill
Ackman picked a turnaround CEO for J.C. Penney who ended discounting,
sending revenue off a cliff. Some make money on companies that ignore
their advice, like Dan Loeb, who couldn’t get Sony
Group (SONY) to break up, and rode shares higher.
And some demand that Olive Garden salt their pasta water. I’m not sure
what that is an example of, but an activist fund called Starboard
it in 2014.
Put aside for the moment matters of incentives, mistargeting, and
optimal tortellini salinity. Do activists make money? There are two
ways to answer that question: not really and no. The first pertains to
long-term excess returns for target companies. They “insignificantly
differ from zero,” according to a 2019 University of Washington study
that weighted companies by market value, like index investors do.
The second answer has to do with returns for investors in activist
funds. There’s a Bloomberg Activist Hedge Fund index that returned
132% over the nine years through the end of 2022, versus 145% for the SPDR
S&P 500 exchange-traded fund (SPY). The Insightia
Activist Index, owned by Diligent, which sells corporate governance
analytics, has a longer run of data, and looks worse for activists.
Last year, activists outperformed. Some of them trumpet past
successes. But, as with active mutual fund managers, that isn’t
necessarily a good predictor. Many companies need fixing. Activists
just don’t seem better at it than the rest of us coaching from the
why do we pay so much attention to Trian’s current proxy fight with Walt
or the four-way activist Hacky Sack game that is (CRM)? “We love these
stories because humans love to watch conflict,” says J.B. Heaton, an
investment lawyer and researcher who wrote a chapter on activism for The
Oxford Handbook of Hedge Funds (2021). “But when you really
push and look...their results are not good.” One exception, he says,
is when activists can convince companies to sell off something
big—because buyers tend to overpay. But he calls their governance and
strategic initiatives “worthless.”
Why, then, are some activist investors so rich? “What really matters
in the money-management industry is having a good story,” says Heaton.
“If you have a good story, you can raise money. And if you can raise
money...you make money off the fees.”
I can’t get Bottom Up off the ground, I have another hedge fund idea.
Investors are betting on a return to low rates, and Wall Street is
suddenly brimming with hot garbage. GameStop
(GME) is up 22% year to date; theater chain AMC
Entertainment (AMC), 49%; Coinbase
Global (COIN), 130%; Carvana (CVNA),
200%; Bitcoin, 42%;
Innovation ETF (ARKK), 42%.
All I have to do is find ill-advised assets that haven’t run yet, load
up, and wait—classic garbitrage. But my first idea, Bed
Bath & Beyond (BBBY), just popped 30% this past
week. And my second, Dogecoin, is
already up 33% for the year. Looks like the blue chips of bad ideas
are already spoken for. I’m currently screening for nonfungible
holographic flatulence tokens, but if nothing turns up, I might have
to dip down in quality.
Write to Jack
Hough at firstname.lastname@example.org.