The spectator sport of activist investing has produced battles this year to rival Ultimate Fighting Championship bouts. But can the people who have turned investing into a head-kicking, nose-grabbing event make money for you?
Some might think it's good that investors have been spared from those punch-ups in the past because the activist strategy involves taking large positions in stocks that might fall sharply before they finally pay off. In some cases, they will lose large amounts. It also means being patient in committing funds to money men with big egos whose confrontations with companies can create uncomfortable situations. Two of the biggest players, Carl Icahn and William Ackman, have recently had on-air screaming matches over nutritional supplement company Herbalife, which has traded erratically as the two legendary investors have taken opposing positions on the stock.
But the wealthy investors and institutions that are able to buy into their funds are not complaining. Icahn's private fund has had annual gains in the 30 percent to 40 percent range, according to research firm reports. Icahn's own net worth has climbed from $100,000 in the late 1960s to $20 billion now. And some see him as a rival to Warren Buffett as the era's top investor. Ackman's Pershing Square Capital Management has also enriched investors. Shareholders see Icahn and Ackman as advocates fighting for their interests, a welcome label for the sort of public agitation that won Icahn and others the title of "corporate raider" in an earlier era. "The stigma that once was there is gone or largely gone. They are more accepted by large institutional investors and corporate managers," says Kenneth Squire, a former mergers lawyer whose research firm 13D Monitor follows the industry.
Smaller investors or hedge-fund copycats play follow the leader whenever Icahn and Ackman file 13D statements, disclosures required whenever an investor takes a 5 percent position in a company's voting shares that may hint at plans to push for measures to influence company performance, which can range from a change of strategy to tossing out management.
Individual investors who mimic the big investors are taking a risk of a big loss because the targets are often companies with problems, and the activist's strategy could backfire and the company's situation could worsen. Moreover, the activist can dump the position at any time without notifying the public, since the position reports come out after the fact. It's like trying to follow a UFC fight from outside the auditorium and deciding what is happening based on the roar of the crowd.
But two fund research firms are betting they can use the activist approach to make money for mutual fund and ETF investors by investing in a range of companies, spreading the risk of a single deal going bad. While it may never be more than a niche investment, the funds have solidly beaten benchmarks over the past year. They use various strategies to screen the crowd noise to figure out what is really happening inside the ring.
A fund run by Squire managed a 20.97 percent gain in the first year of his 13D Activist Fund, or 15.4 percent after its load fee is included. The fund is the purest play for investors who want to buy into the shares of funds that have been targeted by activists like Icahn or Ackman.
Squire completely stayed out of the fight over Herbalife. An active fund manager, he decides based on his own set of factors whether to take sides. Because Ackman had taken a short position betting on the decline of Herbalife stock, Squire stayed out.
While he does not rule out getting into Herbalife at some point, he has not done so yet because his strategy is to avoid situations where investors are betting on company failures. It's one of his rules. He follows all of the 13D filings and then picks a small number to which he can apply these guidelines:
-- Don't get involved when there is a "negative catalyst" who is taking a position, such as Ackman's short position in Herbalife (still, Squire considers the Pershing fund manager one of smartest investors).
-- Invest in situations that include a "positive catalyst" who can "unlock hidden value" that company managers have avoided.
-- Have a deep knowledge of the investor's track record in the sector in which they are investing.
-- Ask in what way will the investor try to influence the company strategy, and does it have a realistic chance of success?
-- Don't get involved in huge deals like Apple where a 5 percent stake is a large amount for activists to keep in place.
-- Take positions that require 18 months or more to pay off in transforming an underperforming company.
The strong recent performance of activist investing has won followers because traditional hedge funds have been underperforming and value investors have been "whipsawed" in trying to find underpriced stocks to buy low and sell high, says another fund manager who tracks activists and hedge funds. The market's sharp ups and downs over the past few years have made value investing difficult.
"Events-driven investing does not follow the market movements as closely," says Maz Jadallah, head of AlphaClone, which runs a similar exchange-traded fund, AlphaClone Alternative, which follows hedge-fund manager investments and uses them in a long-short strategy that aims to even out fund performance. The fund has steadily risen to a 20 percent gain since it began trading last year. News Corp, Delphi Automotive, and Procter & Gamble are among its top holdings.
The fund's largest holding is Apple, whose steep fall has put a lid on the returns of his fund. Jadallah thinks the activist interest of investor David Einhorn in Apple "may or may not be positive." Only time while tell, he says.
Einhorn sued Apple to push for better use of its huge cash pile for shareholders, but recently dropped a lawsuit pushing it to act. Jadallah says he sees the company recovering because it has "seamless and delightful products over a wide range of categories" and has unfairly "been reduced to being just a mobile company falling behind."
The reason to follow activists and hedge fund managers like Einhorn, however, is not that they are always right but "when you invest in them, you are getting the best investment minds in the world," Jadallah says. And some of the scrappiest.
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- William Ackman
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