Corporate America Had Better Take Note.’ Fund Managers Are the New Activist Investors
Barron's
Apr 07, 2019
Consider Wellington Management, the venerated, press-shy $1 trillion firm that, for the first time ever, has publicly opposed management. In late February, Wellington, which runs $359 billion for Vanguard, announced it would oppose Bristol-Myers Squibb ’s (ticker: BMY) plan to acquire Celgene (CELG). Celgene shares fell 8% in a matter of hours.
Wellington’s protest coincided with a behind-the-scenes critique by Dodge & Cox, another old-school money-management firm with $300 billion in assets. In every story about the Celgene deal, Dodge & Cox was described as a detractor.
“If I were asked to rank the most important moments of this era and name the one event that figures to have the most lasting impact, I would save the top spot for Wellington and its decision to become a public shareholder activist,” says Don Bilson, head of event-driven research at Gordon Haskett. “Corporate America had better take note, because the folks who actually pick stocks have finally decided to flex their muscles.”
Most fund managers aren’t publicly embracing this role. Wellington declined to comment to Barron’s. Dodge & Cox declined to comment beyond a statement saying: “We are active, long-term investors—not activists. Our approach is grounded in our commitment to advocating for what is in the best interest of our clients over the long term.”
Activism, it seems, has a public relations problem. There’s a wide spectrum of engagement with companies, including informal chats with executives as a way of testing and developing an investment thesis, making suggestions about capital allocation, and proxy voting. At the bleeding edge of the spectrum are activists: hedge fund firms such as Elliott Management, led by billionaire Paul Singer, Peltz’s Trian Partners, and Ackman’s Pershing Square.
These investors target companies with laggard stock prices, shrinking profit margins or revenue growth, and, often, large cash balances. They typically buy more than 5% of the company’s shares outstanding, requiring them to file a 13D form with the Securities and Exchange Commission, serving notice to the company and the public that they are stakeholders of note.
These activists then begin suggesting fixes for underperformance; their recommendations often involve selling all or part of a company, unseating management, or proposing a new slate of directors. Much, though not all of this sort of activism is for short-term gain, and is expected to bear fruit within a year or so. It isn’t necessarily focused on the long-term health of the company. For example, Icahn announced a large stake in Apple (AAPL) in August 2013, went on to write 37 Apple-related tweets and six open letters saying that Apple should do huge stock buybacks, and dined with Apple CEO Tim Cook. In the 2½ years through the end of March 2016, Apple bought back 1.1 billion shares, and its stock price rose 60%—at which point Icahn had dumped all of his Apple shares.
Such an aggressive posture doesn’t sit well with most mutual-fund managers, who regard themselves as fiduciaries for long-term, retirement-oriented investors.
That’s a large part of why mutual-fund investors eschew the term activist and decline to talk about this sort of work on the record. For example, T. Rowe Price (TROW) officially states: “We do not believe it is T. Rowe Price’s role to initiate activism campaigns.” However, when the firm has a “significant” position in a company targeted by other activist investors, “it is our duty as engaged investors to participate in the process in the interest of reaching the outcome we conclude will produce the best result for our clients.”
Still, more and more firms are privately acknowledging they are making a more activist effort—the preferred term is “engagement”—and doing so behind the scenes. The distinctions they would like to make about their brand of activism are that it’s coming from a collegial, rather than combative place; it’s focused on best practices for governance; and that they will be investors for the long haul.
Last year marked a landslide in activist deals. According to data from Lazard, a record $65 billion in capital was committed to activist campaigns in 2018, up from $62.4 billion the previous year. Some 226 companies were targeted in 2018, versus 188 in 2017. So-called traditional active managers are “increasingly comfortable sharing their views on major activist campaigns in private interactions with management and more public forums,” Lazard noted.
These included T. Rowe Price, which said in December that it continued to support Nestlé’s (NSRGY) board and management as activist Third Point pushed for the food giant to sell its stake in L’Oréal and boost growth; ClearBridge Investments, a unit of Legg Mason (LM); and publicly traded Janus Henderson (JHG), which pushed Athenahealth (ATHN) to consider selling itself after activist Elliott Management offered to buy the company. Then there was Artisan Partners (APAM), which criticized ABB’s plan to spin off its power-grids operation.
Neuberger Berman has taken a more aggressive stance than other mutual-fund managers, advising on capital allocation and running several activist campaigns over the years. Neuberger president Joe Amato tells Barron’s: “We act like an owner.”
Still, the Neuberger version of active engagement “is different from the typical definition of activist,” he adds. “If we have owned a stock for a reasonably long period, and for whatever reason they’re running off the rails—governance, succession planning—we talk face to face. If we’re unsatisfied, we write a letter to the board. We view something more public as a last resort.”
“Crossing the Rubicon is the willingness to go public and go confrontational,” says Benjamin Nahum, manager of Neuberger Berman Intrinsic Value fund, who has proposed directors and mounted proxy fights at about a dozen companies over the past decade. Last year, Neuberger, led by Nahum, urged set-top box provider Arris International to tie executive compensation to plans for capital allocation and acquisitions. Arris adopted the reforms, then agreed to be acquired by CommScope . Nahum says: “I have a pulpit. We owned Arris for 20 years before we engaged them. If you own a company for 20 years, are you a bully?” Nahum says his activism produces “something like 100 to 200 basis points [one or two percentage points] of excess return over the next one to three years” after the campaign gets under way.
Nahum’s colleague Charles Kantor, manager of Neuberger Berman Long Short fund, has sided with specialty chemicals company Ashland Global (ASH) in its fight with activist hedge fund Cruiser Capital, which had proposed its own slate of directors. In exchange for his support, Ashland agreed to find and add two new directors and freshen up its board.
Other companies prefer a more decorous approach. Asked if a fund should make its proposals to a company public,AllianceBernstein (AB) chief investment officer Sharon Fay says: “No. When an activist [then] goes in and talks to a company, the company lawyers up. The dialogue shuts down.” Indeed, companies can spend $10 million to $20 million fighting the demands of activists, according to McKinsey.
In a widely read piece called “The Megaphone Effect,” Fay argues that active managers “can help promote important changes in corporate behavior and help enhance shareholder returns.” Predictably, AllianceBernstein’s list of engagement “wins” doesn’t identify companies by name.
It’s a trend that Fay calls constructivism: “It doesn’t mean [presenting] an 80-page document about the different ways management has screwed up the company.” It often follows an extended period of underperformance. The implication is that the fund manager who supports these reforms will be around in the years to come.
Active managers “have approached us recently with constructivist opportunities—the ability to engage management to act in a more shareholder-friendly manner. Our goal is never to embarrass anyone but rather to work with them,” says Keith Rosenbloom, managing member of Cruiser Capital.
AllianceBernstein has started an internal research collaboration tool that tracks and documents engagements. Under incubation, too, is a fund called AB Concentrated Engagement, which made its first investments last fall in smaller companies “where there’s a greater opportunity to identify misvaluation and help management close that gap,” says Fay.
Fay sees it appealing to institutions and family offices. The fund will tap the expertise of Ali Dibadj, the top-ranked Bernstein Research analyst perhaps best known for telling giantProcter & Gamble to break itself up.
Investors may be scratching their heads—isn’t this, after all, what you pay your mutual-fund manager to do, i.e. represent your interests and produce returns that one hopes will beat the benchmarks? Well, yes. Southeastern Asset Management, which runs the Longleaf Funds, has engaged in activism since the 1990s. Ross Glotzbach, Southeastern’s chief executive, says he wants to see “more than a few examples” of companies “engaging in less high-profile cases, when there’s more behind the scenes work—for example, when they start filing a few 13Ds every year,” before declaring this an impressive new trend. Otherwise, he says, “is that really being engaged? It’s just doing your job.”
That’s fair. Mutual fund activism, after all, is a trend that’s two decades in the making—a result of market and regulatory changes, an increase in investor education, and years of being trounced by index funds. Active managers have been facing more challenges, and most of the changes they’ve been forced to make have benefited investors. Hopefully, activism will continue this trend.
“On the whole, I think it’s a positive for investors, but there are concerns,” says Don Phillips, president of Investment Research at Morningstar. “Fund managers would be finally fulfilling their potential to amplify the voice of the small investor to Corporate America. By uniting many investor voices, these managers can speak more loudly than any of us could on our own. That’s a benefit of fund investing that has been under-deployed to date, and may be a way for active managers to better earn their fees.”
For many, this is a different way of doing business. But the landscape is changing. Big-name activists are getting airtime with traditional mutual-fund managers by joining mainstream industry organizations that help set standards for corporate governance, such as the Investor Stewardship Group and the Council of Institutional Investors Corporate Governance Advisory Council. “They’re socializing before and after the meetings, getting more touches with the funds, and getting a lot more time to develop a rapport that thousands of public companies aren’t getting,” one banker says.
That softer approach is also more likely to win the support of index investors, which aren’t interested in capital allocation but want companies to be sustainable over the long term. After all, BlackRock CEO Larry Fink has criticized short-term activists. “What’s changed over time is the refinement of any activist’s approach,” says Glenn Booraem, head of investment stewardship at Vanguard Group. “Many activists are showing up with a better slate of directors. That’s going to earn then more support from the mainstream.” Index investors are pushing companies to improve performance on environmental, social, and governance factors, which they regard as programs to reduce shareholder risk over the long haul.
But does activism work over the long haul? So far, the data isn’t conclusive. According to data from Activist Insight, 62 so-called “engagement investors,” which are “typically but not exclusively mutual funds,” made demands at companies in 2018. That’s up from 42 in 2014, but down from 81 in 2017.
That doesn’t mean they haven’t stepped up their interactions with companies. “Engagement is difficult to measure,” says Jackie Cook, director of sustainable stewardship research at Morningstar and founder of Morningstar’s FundVotes proxy research unit.
Large investment firms produce engagement reports that give a sense of the issues they’re addressing and how many companies, but not a list of names or the kind of progress they’re making.
Consider the big kahunas of active management: Fidelity Investments and Capital Group, parent of American funds. Morningstar’s Cook looked at 3.5 million votes on director elections and “say on pay” resolutions, where shareholders vote on manager compensation. Over the past several years, both Fidelity and American stepped up their votes supporting governance measures proposed by shareholders, but also tended to vote with management on director elections and say on pay. Fidelity and Capital declined to comment.
Activism should be thoughtful—it isn’t always about battling management. Even so, “not every investment ends positively. That’s life,” says Southeastern’s Glotzbach. “But there’s more upside than downside to people thinking like owners and actual partners in a business.”
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