Tag Archives: investment

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.

Activist Investors Cannot Generate Significant, Long-Term Gains

Originally posted in TheStreet on May 18, 2016. Can activist investors deliver the outsized returns that their actions and rhetoric seem to promise? TheStreet recently published an interesting article about the potential impact of activist hedge fund managers and the failure of mega mergers – sometimes potentially good deals. But the article only touches on part of the dilemma of the whole activist strategy and mania. While activism becomes popular at specific times, particularly in bull markets, the strategy probably cannot generate long term alpha or outperformance. The central problem is that an activist has to have a large position in a stock to have an impact. This is fine in a bull market as stock prices rise. Indeed, it is probable that a large amount of the stock uplift in a position held by an activist has nothing to do with the activism; rather, it stems from buying into a rising market. Naturally, an activist’s buying helps with demand for the stock. But if the wider market declines, the activists’ ‘activism’ tends to become increasingly irrelevant to the direction of the stock (if it ever really was in the first place). In a sudden bear market, activists tend to find they have large concentrated positions that often become highly illiquid – or at least can only be sold down at a significant discount to their then market price. This phenomena wiped out various activists with limited experience in the last credit crisis. They included Aticus Capital , the fund of Timothy Barakett and Nathan Rothschild. Curiously enough, these types of financial models are not uncommon. There are numerous industries that make a significant ROIC during good times, only systematically to wipe out years of historic retained profits in bad times. It is true, for example, of many aviation lessors . These companies are betting not just on aircraft lease rentals, but more importantly on the residual value of aircraft at the end of say a typical 5-year lease. If aircraft values have gone up during that lease period (usually because of benign economic conditions) the lessors make out like bandits. However in an economic downturn, there are fewer passengers, aircraft sit in deserts unused, their rentals collapse, and critically, so do their values. The result is aircraft lessors usually make a nice ROE for a few years and then wipe out most of the last few years’ retained earnings in downturns . For many such companies their long term ROE may even be negative. An honest aircraft leasing executive in presenting his budget would show gradually rising returns for a few years and then suddenly profits falling off a cliff during an expected market downfall. Unsurprisingly, you rarely see such budgets in the industry, as the leasing executive would be unlikely to keep his job for long. Other industries have similar features, including the investment banking industry. Significantly, it seems activist hedge fund managers fit into the same category. They experience a solid and easy run as the equity markets rise and then often a wipe-out of numerous years of return when the market collapses. Large, illiquid positions make orderly disposals, and avoiding such losses, in a downturn extremely difficult. Like the leasing executive, I’ve yet to see an activist investment prospectus that says: “we forecast to make solid returns for a number of years, and then in the next market downturn can be expected to lose our shirt….” There are also now so many managers dabbling in activism that like many hedge fund strategies it has just become ubiquitous. There is the odd activist like Carl Icahn who seems to make it always work, but then in reality he has unique market influence and uses other methods, aside from pure activism to influence management decisions and share price. There are also maneuvers (e.g., taking profits when a merger is announced even if it doesn’t happen, partial hedging of long positions before it’s too late, etc.) that good activists regularly use to mitigate downside risk. But the central long-term flaw in the strategy remains. Approach activism with great caution and do your research. Consider what costs it is worth paying for this type of strategy? The activist may be just a heavily concentrated, long only bull market investor. Probe how he will manage the inevitable downturns? Jeremy Josse is the author of Dinosaur Derivatives and Other Trades , an alternative take on financial philosophy and theory (published by Wiley & Co). He is also a Managing Director and Head of the Financial Institutions Group at Sterne Agee CRT in New York. Josse is a visiting researcher in finance at Sy Syms business school in New York. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of CRT Capital Group LLC, its affiliates, or its employees. Josse has no position in the stocks mentioned in this article.

Oppenheimer Fundamental Alternatives Fund – The Market Knows More Than Ms. Borré

I recently came across a video advertisement for the Oppenheimer Fundamental Alternatives Fund (MUTF: QVOPX ), which is currently headed up by the alpha seeking Michelle Borré. Her pitch revolves around understanding both empirical “hard” data and the human “soft” data to extrapolate information about the future prospects of the market, all while trying to minimize volatility and still produce a solid positive return. This all sounds very appealing, but history has shown that these ideas and, more importantly, being able to anticipate or control them, have largely led to subpar investment performances. In this article , the entire Oppenheimer fund family was examined. The results were not too promising to say the least. Let’s dive deeper and isolate the Fundamental Alternatives Fund to see if there is any merit to the statements being made in their video. What we will show, not only empirically but also theoretically, is that Oppenheimer’s idea of being able to evade volatility or provide a superior understanding of human nature that they can extrapolate any sort of “alpha” from it is built on a false foundation. Let’s start by looking at their past performance based on a comparison to their Morningstar assigned benchmark. The alpha chart below shows their annual alpha (relative performance to the benchmark) since inception in 1999. Click to enlarge What is noticeable is that, overall, the historical performance has not been great. In 13 out of the 17 years, the fund had a negative alpha. On average, it lost by 2.36% per year. If we look at the performance since Ms. Borré took the helm (Nov. 2011), we can also see that she has also not provided superior performance with only 1 out of 4 years showing a positive alpha. Past results are not indicative of the future, but there is nothing substantial here that gives us a promising outlook on this fund’s ability to do what they say they are going to do. This is where theory can provide a more robust explanation of why we would not expect this fund, or any actively managed fund, to turn around in terms of their performance. First, there is the whole idea of trying to minimize volatility while still providing above average returns. Within equities, this involves hedging particular risks associated with stocks, and trying to pick next winner. For example, in its more simplistic form, if we wanted to gain exposure to the financial sector but wanted to remove the risks associated with the financial sector (Beta), we can go long a particular financial stock that we thought was undervalued and short a particular financial stock that was overvalued. We can even go broader and go long a group of financial stocks and short a group of financial stocks. By being long and short within financials, we are removing the systematic risks associated with financials while having a positive exposure to what we think will go up and a negative exposure to what we think we will go down. We are essentially doubling down on our ability to forecast the future. The problem with this approach is that it is very unlikely that Ms. Borré, or anyone, knows any more about a particular stock than the combined information of the thousands, if not millions of investors watching that stock. Remember, the price of a particular stock at any given time represents millions of estimations about the particular value of a given company not only based on information that is currently public, but also future forecasts and even some insider knowledge as well. To be successful in outperforming a market consistently over time, you must have better estimation faculties, quicker access to information, or have inside information, and then exploit that information in a cost effective way. As Mark Hulbert said in his 2008 NY Times article , “the prescient are few”. The chart below summaries the study Hulbert discussed in his article. Click to enlarge This idea also applies to trying to understand human nature or behavior and extrapolate information that can successfully be exploited in investment strategies. It should go without saying that not all investors are trading based on rational expectations as traditional economic theory suggests that people do. We can all think of someone in our life that makes decisions based purely on emotion with no logic at all. We are humans, not robots. The questions is whether or not we can anticipate these events (such as the herding effect we see with large overall movements in markets) and be ahead of anyone else that is trying to take advantage of the same exact “animal spirits” within the markets. Once again, we fall victim to our own estimation limitations as well as not having all and complete information. It is always easy in hindsight to say, “well that looked like irrational exuberance,” but very few actually successfully capture that irrationality in an investment strategy. I published an article that highlighted investment strategies that are based on exploiting behavioral biases. There is no empirical evidence that these strategies have been successful in that endeavor. There is an entire support team at IFA that helps put together these articles. Oppenheimer has been successful in building up their investment assets over time. We have shown that this success is largely built on advertisements, such as the one with Ms. Borré explaining her strategy. While it all sounds very good, a successful implementation of these ideas is not supported by empirical research, has not worked in the past AND more importantly, is not expected to work in the future. Market prices are moved by news and news is random and unpredictable. Let go of the idea that you or a manager you select will have wisdom greater than the market. Just index and relax. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.