Activist strategies have been popular with hedge fund investors in recent years and have enjoyed net inflows through this summer, but performance data suggests that the strategy is starting to slip. What’s more, the big-name activists are having a tough time identifying new targets. If investors just getting into the strategy are looking to managers who target large and megacap companies only, they may be behind the trend. Some smaller activist funds are now touting their acumen with investing in smaller or non-U.S. companies in a bid to woo these investors.
Activist funds declined by 2.03 percent on average in June, according to Atlanta-based hedge fund tracker eVestment. That’s compared with a 0.86 percent gain for hedge funds in aggregate. The activist group is also negative for the year through June by 0.9 percent, while hedge fund performance overall has turned positive.
Valuations in the U.S. have hit new highs, limiting the options for activists that are hoping to extract value. With only a finite number of large and megacap companies to invest in, there are only so many events per year where big funds can hope to capture upside.
As a result, some managers are going abroad into such regions as the European Union, where pockets of distress have created more turnaround opportunities. Others, like Newport Beach, California–based Engaged Capital, are going after smaller targets. The team at Engaged, which manages $400 million, left $6 billion, San Diego–based Relational Investors, a large-cap activist manger, to focus on small and midcap opportunities.
Glenn Welling, principal and CIO at Engaged, says the lack of analyst coverage and managerial experience at small and midcap companies creates an opportunity for investment teams willing to do the work.
“With small and midcap companies, we are very rarely in the same activist position as another investor,” Welling says. “There is less coverage of these companies, and that gives us the opportunity to bring in our experience and generate uncorrelated, private equity–like returns.” So far, the firm’s performance bears that out: Engaged is up approximately 5 percent year to date.
Going small to win big is a strategy that has been tried before. Jeffery Smith’s Starboard Value, a New York–based activist firm with $4.7 billion in assets, focused on midcap companies in its early days, achieving success in executing turnarounds at companies like Darden Restaurants. But the firm’s rapid asset growth pushed Smith and his colleagues toward bigger targets, like Yahoo!. That company reported another earnings loss last Monday, marking the sixth-consecutive earnings decline for the company.
Big targets like Yahoo can be harder to turn around or sell and often come with significant tie-ups like Yahoo! CEO Marissa Mayer’s $54 million exit package. Starboard Value now occupies half of the board seats at Yahoo, but it is unclear whether the sale of the company to Verizon for $4.83 billion will turn out well for investors. The sale comes at a significantly lower number than Yahoo’s peak valuation of more than $125 billion in 2000 at the height of the dot-com era, or even Microsoft’s rejected $44.6 billion takeover offer in 2008.
Meanwhile, some of Engaged’s small and midcap targets have ended up on the lists of big hedge funds that are interested in capturing the rewards from activist interest. Bellevue, Washington–based Outerwall, a provider of movie and video game rental kiosks, is also held by New York–based Fine Capital Partners; Stamford, Connecticut–based Point72 Asset Mangement; and East Setauket, New York–based Renaissance Technologies. The company’s stock is up 19.46 percent for the year through July 11.
Another holding — Angleton, Texas–based Benchmark Electronics, a provider of white label electronics systems — is up 5.9 percent year to date. Boston-based Arrowstreet Capital, New York–based D.E. Shaw and New York–based Renaissance Technologies all have positions, among others.
These smaller targets aren’t as correlated to big market moves and often behave more like activist and value opportunities in the classical sense — and that’s likely what these funds and their investors are after. Jeffrey Mitchell, principal and senior investment consultant at Boston-based pension adviser NEPC, which advises on $910 billion in pension assets, says that it’s often hard for equity investors to find differentiated strategies. “Investors are on the hunt for uncorrelated returns, and activism can offer that even if the strategy is challenged now,” he says.
