Tag Archives: investing-strategy

The Jury’s Still Split On The Value Of Activist Investing

Activist investing continues to be a topic of great debate in the financial world. One of the main issues that drives the controversy is whether activist investors help or hinder the market. Are they a force for good that keeps management and boards honest? Or are they simply quick buck artists intent on creating short-term value at the expense of building long-term sustainable companies? With these questions in mind, we asked CFA Institute Financial NewsBrief readers the following: “Is activist investing helpful, harmful, or a short-term nuisance?” As you might expect, opinions were split almost right down the middle. Is activist investing helpful, harmful, or a short-term nuisance? Click to enlarge Nearly half (48%) of the 538 respondents felt that activist investors are good for the system and improve the quality of the firms they invest in. Just over half of those surveyed, however, offered a less sanguine view of activist investing, split between those who feel activist investors are harmful to the system and are often motivated by short-term profit at the expense of long-term investors (34%), and those who say activist investors are a short-term nuisance and have little long-term effect on a company’s performance (18%). So what is the answer? Is activist investing a problem or not? As typical humans with short attention spans, we demand an easy answer! Unfortunately, as with most questions of this sort, the answer is typically yes and no, depending on your perspective. By its very nature, shareowner activism does often seek to return cash to shareowners in some form in a relatively short time frame. But activists rarely pursue corporate prey that has been executing consistently on a proven strategy for years. Activists tend to target companies that have lost their way in one way or another. There is also a definitional problem with short-termism. The markets work because someone is willing to buy or sell in the short term, often with an unknown time frame. If an investor feels that the full value of their investment is reached in three years, three months, or even three minutes, we do not begrudge them the right to sell. Activism has increased in recent years because it is believed to be a profitable strategy. It will likely decline as a strategy when and if there is less low hanging fruit — when there are fewer poorly run companies or firms with poor strategies. If management and boards up their games, their companies will not look so attractive to activists. Corporate boards also have reasonable allies in the battle against those activists motivated by short-term considerations: long-term investors. Long-term investors are typically institutional investors and generally do not have the option of selling the companies they own, so they can be receptive to a strong argument from an activist looking to drive value. It is therefore incumbent upon management and boards to: Have a sound long-term strategy. Tie variable compensation to the execution of that long-term strategy. Foster a dialogue and ongoing relationships with long-term investors. By engaging with these investors consistently and effectively, companies earn their trust. Then, if an activist comes to their door, they have a more receptive investor ear in the contest of ideas that plays out in the media and corporate boardrooms.

A Quick Example Of Rebalancing Theory At Work

I know I go on and on about disciplined rebalancing. In this article , I also address the concept that each asset class in your portfolio can be viewed as a form of “currency,” and can be expensive or cheap. Today, I merely wanted to share a quick real-world example of how this worked in my personal portfolio. The picture below is a 6-month graph from Yahoo Finance. The blue line represents the Vanguard REIT Index ETF (NYSEARCA: VNQ ), the red line the Vanguard Utilities ETF (NYSEARCA: VPU ) and the green line the S&P 500 average. Click to enlarge You will quickly notice that both VNQ and, even more dramatically, VPU have outperformed the S&P. As a result, the “overweight” indicator recently flashed up for both of them in my portfolio, to the tune of about 7-8% overweight. The red arrows represent my two recent sales to bring them back in line; VNQ on 5/9 and VPU on 5/13. Want to know a little secret? As I write this, both are now slightly underweight in my portfolio. The sharp drop you see in both at the very end of the graph is because the Fed minutes released today appear to indicate that a June rate hike is back on the table. As a result, all interest-rate-sensitive asset classes took a beating. So, now I have an opportunity to watch for a chance to possibly buy back in at lower prices. Not because I’m brilliant. Simply because I monitored and acted on my weightings in a disciplined manner.

Gamable EPS And Share Buybacks

EPS (Earnings per Share) is a corporate metric that is often pursued by the corporate managers and executives to increase their own payouts, and confused by investors for a signal of company health. As is well known (and we show this in our Risk & Resilience course), EPS is a “gamable” metric – in other words, it can be easily manipulated by companies, often at the expense of actual balance sheet quality. And I have written about this problem here on the blog for ages now. So, here is a fresh chart from the Deutsche Bank Research (via @bySamRo) detailing share buybacks’ (repurchases) contribution to EPS growth: In basic terms, there is no organic EPS growth (from net income) over the last 7 quarters, on average, and there is negative EPS growth from organic sources over the last 4 consecutive quarters. As noted in my lecture on the subject of “EPS gaming”, there are some market-structure reasons for this development (basically, rise of tech-based services in the economy): Click to enlarge Source of Data: McKinsey Click to enlarge Source: McKinsey However, as the chart above shows, share buybacks simply do not add any value to the total returns to shareholders (TRS), and that is before we consider a shift in current buybacks trends toward debt-funded repurchases. So, in a sense, current buybacks are rising leverage risks without increasing TRS. Which is brutally ugly for companies’ balance sheets, and given debt covenants, is also bad news for future capex funding capacity.