Hedge Funds

No Barbarians at the Gate; Instead, a Force for Change

Alexandra Stevenson

It's no longer an insult to be called an activist investor.

Once painted as greedy corporate raiders, they would amass large stakes in a company and, through brute force, push for changes in the company's leadership and business practices. They reveled in their image of attacking the fortress of corporate America. Now, some three decades later, their efforts have become more sophisticated and they are often seen as a good thing, shaking up companies too entrenched in their ways.

The beneficiaries of this new attitude are activist hedge fund managers like David Einhorn and Daniel S. Loeb, who last year rattled the corporate boards of some of America's biggest and best-known companies. They are beginning the new year with swelling coffers and more public support than ever before.

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David Einhorn, president and co-founder of Greenlight Capital
Scott Eelis | Bloomberg | Getty Images

The industry suffered middling returns compared with the gravity-defying stock market in the United States, but some activist hedge funds outperformed stocks last year. And in a show of support, investors poured an estimated $10 billion to $12 billion of new money—a record—into the funds' war chests, bringing their total assets to more than $100 billion,according to data from Hedge Fund Research.

Even Mary Jo White, the Securities and Exchange Commission chairwoman, has taken note of the increasingly important role played by activist investors. "It was not that long ago that the 'activist' moniker had a distinctly negative connotation," Ms.White said in December at a conference on corporate governance in Washington."But that view of shareholder activists, which has its roots in the raiders of the 1980s takeover battles, is not necessarily the current view and it is certainly not the only view."

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Activist investors, who buy up shares in a company with the intention of gaining enough control to demand changes to its business, are best known for publicly admonishing executives as lazy and overpaid and calling on companies with huge cash piles to share their riches with shareholders.

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At a time when companies have borrowed record levels of cash but are doing little with it and regulators are drawing more attention to corporate governance issues like soaring executive pay, the calls from these activist investors resonate.

And investors say they like their performance record. In 2013, activist funds returned around 18 percent to investors, compared with an industry wide average of 9 percent, according to Hedge Fund Research.

A series of prominent campaigns last year helped to make the public case for hedge fund activists. An attempt by Mr. Einhorn of Greenlight Capital to force Apple to return some cash in the form of preferred stock failed in February, but Apple later agreed to return part of its $137 billion cash pile to shareholders through a buyback and a bigger dividend. Carl C. Icahn, the billionaire activist, followed with demands for an even bigger dividend, airing his views through the media and on Twitter.

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The most striking success story last year began with a relatively minor assault on Microsoft. In April, when the $12 billion hedge fund Value Act Capital announced that it had acquired a stake in Microsoft of less than 1 percent and was seeking change at the top, it seemed unlikely to prevail. But by August, Microsoft's chief executive, Steven A. Ballmer, announced that he was stepping down after 13 years in the job.

"In the wake of the downturn five years ago, companies were able to tell investors, 'Everything has crashed and we're all in the same boat together,'" said Christopher P. Davis, a partner at Kleinberg Kaplan Wolff & Cohen who represents activist investors. "The problem is that the stock market has rocketed up and the competition has taken advantage of that. Any laggard that is not anywhere near where the market has gone has a difficult time explaining why they are still trailing behind."

Much of the new money flowing into activist funds is coming from institutional investors like corporate and state pension fund managers and endowment funds, many of which would not have put their money with activist investors before the financial crisis for fear of having their reputation tarnished.

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"We think they can go in and make improvements in companies that benefit shareholders in the long run," said Anne Sheehan, director of corporate governance at the California State Teachers' Retirement System, which manages $176 billion. The California teachers' fund, known as Calstrs, first began investing strategically in activist hedge fund managers in late 2008.

Last year, in a first for Calstrs, it joined the hedge fund Relational Investors in leading a proposal to split the Timken Company into separate steel and industrial bearings businesses. Months later, the company agreed.

Less patient than they used to be, institutional investors now weigh in, often to tip the scales in favor of activists.

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"It used to be that boards of decent-sized companies were impenetrable," said William A. Ackman of Pershing Square, an $11 billion hedge fund. "What's changed is that institutions are prepared to replace directors,including the chairman and chief executive in light of under performance."

Pershing Square had a mixed year after Mr. Ackman was forced to retreat from a fight with the board of JC Penney, three years after he first invested in the company with the belief that new management could turn around the business. He brought in Ron Johnson, a former Apple executive credited with establishing Apple's retail strategy, but the decision turned out to be catastrophic.

One of his most successful campaigns last year, though, and Pershing Square's biggest activist bet yet, underscores how things have changed for activists. In August, three months after Pershing Square took a $2.2 billion stake in the industrial gases group Air Products and Chemicals, John E. McGlade, Air Products' chief executive and chairman, announced his retirement. The board also ceded two directorships to Pershing Square.

Activist investors, for their part, have become more constructive in their analysis of how companies can improve their businesses. In the days of corporate raiders, investors needed to own a large portion of a company to throw their weight around and make changes in a company.

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"The brute force of ownership is not required anymore because the big institutional players listen to both sides and are willing to back the activist fund if they believe in them," said Gregory P. Taxin, president of the $1.5 billion hedge fund Clinton Group and a co-founder of Glass Lewis & Company, the independent research and proxy advisory firm that provides analysis to institutional investors to help them make informed decisions on corporate governance.

"You can win with persuasion and ideas," Mr. Taxin added.

But even though activists are more refined in their methods today, many keep a bully tactic or two in their back pocket.

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A partner at one activist hedge fund, based in New York, has a mug he likes to use during talks with corporate executives. The mug features the photographs of chairmen his hedge fund has removed in earlier activist campaigns.

If this is not persuasive enough to make the executives pay attention, the hedge fund manager, who spoke on the condition of anonymity, will threaten to take his activist case to the public.

"There's one line that works," he said. " 'We can make you famous, and not for the reason you want to be famous.' "

—By Alexandra Stevenson of The New York Times.