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New Alliances in Battle for Corporate Control

For ages, institutional investors like mutual funds and pension funds were content to take stakes in public companies, trust their managements and bet on long-term gains. Companies trusted that these investors would be passive shareholders and not rock the boat.

The abrupt rise and increasing success of activist investors, however, are forcing big money managers like BlackRock, T. Rowe Price and Vanguard to question these long-held assumptions.

Mutual funds and other big money managers, which now control a record share of public company stock, are working with activist hedge funds behind the scenes, pressing for change at underperforming companies in their portfolios and lending their support to calls for management shake-ups. In some cases, the institutional investors are even stepping out from the shadows to pick their own fights.

"This is the biggest shift in the battle for corporate control since private equity was invented in the 1980s," said James Rossman, head of corporate preparedness at Lazard. "Activists realize they can influence this concentrated shareholder base at many companies, and they're tapping into the desires of shareholders to see change take place."

It is now common to see institutional investors support activist campaigns. T. Rowe Price backed Carl C. Icahn's opposition to the leveraged buyout of Dell last year. Southeastern Asset Management, which worked with Mr. Icahn on a rival bid for Dell, also quietly supported the Barington Capital Group's campaign for change at the retailer Dillard's.

But traditional investors are not simply supporting activists once a campaign has begun. They are constantly discussing a variety of companies, and in some cases, the institutional investors are even giving ideas to the activists.

"Periodically, we are approached by large institutions who are disappointed with the performance of companies they are invested in to see if we would be interested in playing an active role in effectuating change," said William A. Ackman, founder of the $13 billion hedge fund Pershing Square Capital, who is best known for his positions on J.C. Penney and Herbalife. Institutional investors even have an informal term for this: R.F.A., or request for activist.

Several factors are contributing to the more robust dialogue between traditional investors and activists. Many activist hedge funds have outperformed traditional index funds in recent years, emboldening activists and causing traditional money managers to take note.

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Rishi Bajaj of Altai Capital, a hedge fund that oversees $400 million, pointed to his firm's work at SunEdison, a solar power company. Altai took a board seat in late 2012 and began working more closely with management. Since the hedge fund first became involved in mid-2012, shares of SunEdison have jumped 970 percent, and the company now has a market value of $4.9 billion.

Though data tracking the success of activist campaigns is imprecise, hedge funds that pursued a proxy fight to its conclusion won 20.7 percent of the time last year, according to FactSet. That is up from 9.5 percent in 2012 and 7.4 percent in 2011.

Activists may have also done themselves a favor by cleaning up their image. Many prominent agitators no longer issue the management-bashing poison-pen letters that once characterized the industry. Even Daniel S. Loeb, who made eviscerating company executives by letter into something of an art form, has been more sparing in his use of the tactic. He repeatedly had kind words for Sony when he sought to persuade it to partly spin off its entertainment arm, avoiding an all-out brawl.

"I think activists in a lot of ways have been given a bad rap because some used to lob insults from afar," Mr. Bajaj said. "I do think activism is becoming more and more intelligent."

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Many institutional investors concur, adding that dialogue with activists has increased markedly over the last year.

"The key thing that's changed is that more mainstream investors are willing to give an audience to activists," said an executive at one large institutional investor. "In part, that's because the activists have become more sophisticated in how they present their arguments."

And what was once a knee-jerk reaction by many institutional investors, who previously steered clear of activists, has softened into something closer to collaboration.

"We don't have a house view, whether pro-activist or anti-activist," said Glenn Booraem, controller of the Vanguard funds. "We're pro long-term value creation."

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The dialogue between activists and institutional investors often begins even before a fight has gone public. Hedge funds want to make sure that other big investors in a company share their views before they take a big stake and press for change.

For example, before going public with its fight against Agrium, the Canadian fertilizer company, the activist hedge fund Jana Partners talked to several of the company's top investors in a bid to gauge their support for its campaign to increase the share price, including advocating the possible spinoff of the company's retail agricultural division. Had other shareholders not supported Jana's position, which was ultimately unsuccessful, the fund was unlikely to have pursued it alone.

And when ValueAct, a relatively unpublicized activist hedge fund, took a small stake in Microsoft last year, it did so knowing that some of Microsoft's largest and oldest shareholders supported its view that change was needed at the company. Though ValueAct had bought less than 1 percent of Microsoft's stock, the company granted the fund a board seat, recognizing that the hedge fund was speaking for other investors, too.

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Other activists contend that they hold only passing conversations with shareholders of prospective targets, believing that divulging information about their plans could spur a rise in the companies' stocks, making an activist campaign significantly more expensive.

Once campaigns are underway, both activists and companies seek to enlist the support of institutional investors. After Mr. Icahn took a stake in Transocean, he met with the company's big investors at least six times before its annual meeting.

"When contentious situations arise with companies in our portfolios, we have always found it useful to hear perspectives from both sides of the debate," said Donna F. Anderson, corporate governance analyst at T. Rowe Price. "This approach enables us to make more fully informed decisions about the outcome that would best serve the long-term interests of our clients."

Much rarer, activists say, is a traditional money manager giving a bomb-throwing hedge fund a specific target and goal. Another hedge fund executive recalled hearing several years ago from a portfolio manager at a big institution eager to force a sale of Dobson Communications, a rural cellphone service provider.

The portfolio manager couldn't apply pressure directly on the company, but he encouraged activists to take up the cause. It isn't clear whether hedge funds complied, but Dobson eventually sold itself to AT&T for $2.8 billion in the summer of 2007.

"Institutional investors want to share the sick children in their portfolio with someone who can help make them better," said Bruce H. Goldfarb, chief executive of Okapi Partners, a proxy solicitation firm.

In certain circles, T. Rowe Price, an institutional investor with $614 billion in assets under management, has gained a reputation for pursuing hedge funds and encouraging them to take up an activist campaign. The firm denies it suggests certain targets for activists but acknowledges it is in regular dialogue with other investors about the companies in its portfolio.

At other big firms like BlackRock, which manages $4.3 trillion, the lines are more blurred. BlackRock denies that any of its portfolio managers pursue hedge funds with ideas, but some portfolio managers are said to pass on certain ideas.

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Many activist hedge fund managers are reluctant to publicly acknowledge that they receive ideas from other investors, but concede in private conversations that it is common practice to discuss stock ideas with institutional investors.

One employee at a big New York hedge fund said that the exchange of investment ideas between institutional investors and hedge funds was typically more subtle. "Shareholders talk to shareholders," he said. "In the course of ordinary conversation, it comes up."

With institutional investors now regularly supporting activists, some are even taking the next step and effectively starting activist campaigns of their own.

Last year, the California State Teachers' Retirement System, which manages $176 billion, teamed up with the hedge fund Relational Investors to undertake a campaign to split the Timken Company into separate steel and industrial bearings businesses.

Months later, the company agreed. Likewise, in 2011, the Ontario Teachers' Pension Plan worked with Jana Partners to press McGraw-Hill to spin off part of its business. McGraw-Hill eventually broke itself apart, though company executives said at the time that they had already been weighing a split by the time Jana had arrived.

At some point, activists will not even be considered activists anymore; they will just be thought of as ordinary investors, said Michael Carr, head of Goldman Sachs's mergers and acquisitions group in the Americas. Already, he said, "the boundary between long-only money managers and activists is starting to blur."

By David Gelles and Michael J. de la Merced of The New York Times

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