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Jul 30, 2019
Wealth | Karmic reckoning? Investors in activist hedge funds agitate for change
Svea Herbst-Bayliss
6-8 minutes
(Reuters)
- Frustrated by high fees and uninspiring returns, pension funds,
sovereign wealth funds and other big institutional investors are
demanding U.S. activist hedge funds be more transparent about their
investment ideas and charge less, investors and fund managers say.
FILE
PHOTO: Nelson Peltz founding partner of Trian Fund Management LP. speak
at the WSJD Live conference in Laguna Beach, California October 25,
2016. REUTERS/Mike Blake
Activist
hedge funds push for changes at companies, ranging from ousting
management and board directors to buying back stock and divesting
non-core assets. Traditionally they have used capital from their total
pool of investor money to build stakes in companies, without telling
clients in advance what their targets and strategy will be.
They
then go “active” and call for changes in some of the companies they
invest in, but charge the same fees for all the money that investors
place with them.
Now, institutional investors are
increasingly pressuring the hedge fund managers to raise separate pots
of capital for each company they target through so-called special
purpose vehicles, and have been able to drive down how much they pay for
investment gains.
Fund managers now have to bring their best
ideas, fully formed and described in detail in glossy pitch books,
outlining to their investors exactly how they plan to drive up a
company’s stock.
“This structure lets us look at dozens of
transactions and only invest in a manager’s very best ideas,” said Gregg
Hymowitz, chief executive officer of EnTrust Global, one of the largest
investors in special purpose vehicles raised by activist hedge funds.
“For lower fees and with an increased level of transparency, we can
specifically target only the highest-conviction ideas of our partners.”
There
is no industrywide data on the proliferation of these pools of capital,
often referred to as co-investments or sidecars, because fundraising is
confidential, but investors and fund managers said their use is
growing.
Some of the industry’s most prominent activists,
including Nelson Peltz’s Trian Fund Management LP, Keith Meister’s
Corvex Management LP and Glenn Welling’s Engaged Capital LLC, are
increasingly relying on special purpose vehicles to raise money. Smaller
players like J. Daniel Plants’ Voce Capital Management are also turning
more to co-investments for their campaigns.
The fund managers either declined to comment or did not respond to a request for comment.
Electronics maker Sony Corp (6758.T), retailer Bed Bath & Beyond Inc (BBBY.O), building materials producer Eagle Materials Inc (EXP.N), insurance company Argo Group International Holdings (ARGO.N) and specialty chemicals provider Ashland Global Holdings Inc (ASH.N)
are among the companies that were targets of campaigns mounted by
activist hedge funds through co-investments, investors said.
The companies either declined to comment or did not respond to requests for comment.
The
proliferation of special purpose vehicles underscores how activist
hedge funds, run by some of the biggest personalities in the industry,
have lost some of their star power, as returns and assets under
management have sagged amid increasing competition and misplaced bets on
overvalued companies.
“Previously fund managers were almost
always in the driver’s seat. That has changed for many now,” said
Eleazer Klein, a partner at law firm Schulte Roth & Zabel, who
advises activist investors.
Last year activists lost 10.4%
on average, far more than the hedge fund industry’s average 5% drop,
according to data from research firm Hedge Fund Research. Assets under
management shrunk by 16% from their peak in 2015 to $146 billion at the
end of last year. Activist hedge funds are performing better this year,
returning 10.1% in the first six months of 2019, according to HFR
data.As demand for activist funds dried up at a time investors wanted
less exposure to stocks, they suddenly had significantly more power to
dictate terms in return for their multi-million-dollar investments.
Managers who needed the cash were ready to compromise on fees.
Hedge
funds have traditionally charged a 2% management fee and 20% of the
gains. Co-investments often charge no management fees and require
investors to pay only 10% of the profits. In addition, fees, instead of
being collected annually, are collected only at the end of the
investment period, which tends to be longer, between three and five
years, managers and investors said.
CURBING ABILITY TO MOVE AT
WILL Some fund managers complain that the shift in the fundraising
model is cumbersome and limits their ability to target companies when
they are ready and to do so in secret.
It can also raise the risk
of a leak that can drive up a target’s stock price and give the target
an opportunity to line up defenses.
Sony, for example, was
able to hire investment bankers and prepare its strategy weeks before
Daniel Loeb’s Third Point approached it with its demands, after Reuters
reported in April that the hedge fund was raising a special purpose
vehicle to target the Japanese company, according to people familiar
with the matter.
But special purpose vehicles have advantages,
too, giving activists access to more cash than they normally would be
able to deploy, allowing them to go after bigger companies.
FILE
PHOTO: Keith Meister, Managing Partner and Chief Investment Officer of
Corvex Management, speaks during the Sohn Investment Conference in New
York City, U.S., May 8, 2017. REUTERS/Brendan McDermid
In
the case of Sony, Third Point built a $1.5 billion stake with the help
of co-investment, a big bet that would have run afoul of rules of how
much money Loeb could allocate to a particular bet in his main $15
billion fund, according to investors.
Third Point did not respond to a request for comment. Sony declined to comment.
“Fund
managers find it an efficient way to raise capital, it is a win-win,”
said Corvex’s Meister, who has raised several billion dollars for
co-investments over the last years.
Reporting by Svea Herbst-Bayliss in Boston; Editing by Greg Roumeliotis, Paritosh Bansal and Leslie Adler
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