Public Perception of Activist Hedge Fund Managers

  1. What Makes Them So Active?
  2. Classic Examples
  3. In The Public Eye
  4. Blue Horseshoe Loves Anacott Steel
By Unknown author — This file has been extracted from another file, Public Domain,

Heroes of the investing world, activist hedge funds enjoy relative anonymity in the public eye. Considering their outsize impact on our daily lives, this anonymity is quite strange. Interest in these funds, which generally only flares up when news breaks, has been reignited recently by Elon Musk’s foray into the field — acquiring Twitter in a relatively hostile takeover last month. In light of this most recent surge, the convoluted web of institutional money, back-room deals, and self-serving company leadership battles that makes up the world of activist investing is worth a deeper look.

What Makes Them So Active?

Hedge fund is a broad name. Rather than simply hedge bets, like they used to, modern hedge funds pursue countless strategies ranging from long-term holds of concentrated stock positions based on deep fundamental research to fixed-income derivative arbitrage executed in milliseconds — and everything in between. Activists are a relatively niche subset of the hedge fund world, comprising ~$200.7B of the hedge fund industry’s over $4T in assets under management.

As for their strategy, Matt Levine explains it succinctly:

The way activist investing works in the U.S. is generally that an activist investor quietly buys up a chunk of a company’s stock, announces that she owns the stock, and goes to the company’s managers asking them to change something about their strategy or operations. Sometimes the managers agree, there is a productive conversation, the activist helps the company improve, the stock goes up and eventually the activist sells at a profit. Sometimes the managers disagree, and the activist tries to pressure them into doing what she wants.

As such, you can think of them as opportunistic investors who try to use private equity type buy-and-fix strategies on publicly traded companies. These funds often work together informally, forming a “wolf pack” to gang up on weak corporate management teams. These attacks can be funded by larger institutional investors (like pension funds), who often escape any blame for failed or overzealous campaigns (WLRK).

Classic Examples

As mentioned above, activist campaigns have huge impacts on our lives. From efficiency improvements to fire sales, emissions reduction to union-busting, activists can campaign for essentially anything. Some of the most notable campaigns even manage to capture the public’s attention. Recent examples of this phenomenon include Engine № 1’s activist campaign against Exxon last summer.

As explained by the Journal, Engine № 1, a tiny start-up fund, managed to land 3 seats on Exxon’s board despite owning ~0.2% of the company at the beginning of the campaign. The campaign centered around improving sustainability, primarily by reversing a culture of climate change rejection that had resulted in decades of poor investment decisions by the company’s upper management. After publicizing his manifesto, fund manager Christopher James was able to convince larger investors like CalPERS, Vanguard, State Street, and BlackRock to take his side — an unusual move by these generally passive money managers. Though they haven’t been able to accomplish much yet, this type of activism has the potential to completely change a company’s focus. Should activists continue to target Exxon and gain a majority on the board, they could fire the company’s entire management team and replace the with environmental scientists if they wanted. How’s that for active.

Farther back, in 2013, another classic activist campaign captured similar news coverage. Starboard Value, headed by Jeff Smith, launched an attack on Darden Restaurants Inc. The complaints against Darden, which owns brands like Olive Garden and LongHorn Steakhouse, initially hinged around the too-cheap planned sale of Red Lobster. Far from ending there, Starboard’s list of grievances expanded as they began to pick up more momentum. By September 2014 Starboard was embroiled in a proxy war, attempting to seize total control of the board. To support their case, they released a 294-slide presentation detailing changes they’d make if given control of the company. The granular nature of these demands sparked conversation and even laughter, eventually being covered by John Oliver’s Last Week Tonight.

In The Public Eye

While these funds directly impact our lives — creating, spinning off, changing, or destroying companies we interact with, much of the public discourse surrounding them lacks context. Customers, employees, and the general public generally don’t view ‘unlocking value for shareholders’ with as much enthusiasm as investors. Change can come in many forms, but lay-offs, spin-offs, and price hikes tend to garner the most public attention.

A recent example of activist activity generating an online debate comes from Alta Fox Capital, a small-cap focused long-short equity fund managed by Connor Haley. In February of 2022, Haley’s team built a 2.5% stake in Hasbro and launched a relatively public proxy fight.

Nominating 5 directors for the board, Alta Fox’s chief demand was that the Wizards of the Coast and Digital Gaming unit should be spun-off into an independent company. Despite its unassuming name, the Wizards of the Coast (WotC) is a gaming powerhouse. Their IP includes Dungeons & Dragons and Magic: The Gathering, and they were the initial distributors of US Pokémon trading cards. This divestiture, according to Alta Fox, would allow better visibility for the fast-growing unit, as well as increased reinvestment rather than having unit profits siphoned off to support under-performing legacy Hasbro IP.

Alta Fox, Feb. 2022

Initial reactions from shareholders were muted, with the stock continuing to fall in line with the market over the next few months. Players of Magic and D&D, however, hit social media in a flurry of activity. Podcasters and community figures sounded off on the move. some with nuance and some highly critical:

Players joined the discourse immediately, with posts on garnering thousands of upvotes and hundreds of comments, ranging from delusional to extremely helpful.

Initial responses seemed conflicted, likely due in part to Alta Fox’s pandering to the player-base. The fund set up a user-friendly website explaining their ideas, as well as publishing an additional 100-slide deck with the more detailed financial research pictured above.

As the year progressed, Alta Fox had some trouble gaining traction. The campaign was flat-out rejected by management, and commentators remained skeptical on benefits for players. After a rebrand and continued pressure, Hasbro forced a vote at their annual meeting. The two large proxy advisory firms, ISS and Glass Lewis (which make voting recommendations to institutional investors) decided to back Hasbro’s existing board. By early June, 2022, the proxy fight was resolved with Hasbro coming out on top. Despite reducing the scope of their requested changes, Alta Fox was unable to convince large institutional investors to back their stance.

In the end, little has changed for the broader Magic and D&D communities. Despite much hand-wringing, the games will continue to be managed by a toy company that has somehow managed to miss out on both the rise of video games and the recent counter-trend of board game popularity. Would they have been better off? No one can know for sure. It is clear, though, that when something like this happens in a community you care about, paying close attention is well worth your time.

Blue Horseshoe Loves Anacott Steel

With the recent uptick in activism has come renewed scrutiny of the practice. Gary Gensler, Biden’s appointed SEC chair, has implied multiple times that he considers activist intent to be akin to insider trading. In January, CNBC reported his statements as such:

“It’s material nonpublic information that there’s an activist acquiring stock, who has an intent to influence and generally speaking, there’s a pop if you look at the economics from the day they announced … there’s usually a pop in the stock at least single-digit percent,” Gensler said. “So the selling shareholders during those days don’t have some material information.”

This take, though supported by transparency and disclosure advocates, was hated by the activist industry. The prior regulation required a public filing (a 13D) within 10 days once an investment firm’s stake in a company went above 5%. The new rule shortens it to 5. In this time, the activist can continue to buy stock in secret, using well spaced-out small purchases that don’t move the market too much. With the shorter period, activists with larger asset bases will have some trouble buying their intended stake without attracting attention — discouraging making the investment in the first place. As reported by Institutional Investor, industry leading firms like Elliott Management are claiming that these rules will snuff out their business model, despite their ability to generate socially favorable changes. This drama will continue to play out in the coming months, as it’s safe to say the SEC and hedge fund managers aren’t seeing eye-to-eye here.

Beyond the simple timing of an investment, there are many problems with the ways that activist investors disclose their positions. Often, there is little information about how these funds have communicated with company management and what exactly they are pressuring them to do in those conversations. 13D filings state only imprecise legalese, often giving no indication at all what the activist intends to do with the company. Directly relevant to the company’s other stakeholders, it’s strange that in an era of electronic filings comma the SEC wouldn’t require more precise disclosure.

Returning to Elon musk’s takeover of Twitter — there were quite a few of these closed-door agreements that made it possible in the first place. Elliot Management has held a multi-year activist stake in Twitter, winning a board seat and selling off a large stake to private equity co-investors. as reported by Axios in November 2021, this new board secretly moved to restructure Twitter’s executive team. eventual culmination of these power plays was the removal of Jack Dorsey, founder and longtime CEO of Twitter. despite Elliott eventually giving up their board seat, it is certain they were pushing for this change. What’s less clear, due to this persistent lack of transparency, it’s the influence they had on the selection of Parag Agrawal as replacement. This management shakeup and removal of Twitter’s most company-aligned executive opened the door for a hostile takeover. Intentional? Impossible to say. But a little more transparency from the firms ruling our avenues of public discourse would go a long way.

Elon’s behavior post-acquisition serves as a stark reminder that activists are often on the opposite side of users. Massive layovers that threaten to cripple the service, paid subscriptions for once-free features, and a totally-not-biased view on moderation have left account-holders and advertisers extremely unhappy. Elon, to his credit, decided it wasn’t his fault.

At the end of the day, activist events are hard to predict and harder to understand. Their secretive nature and pre-internet era disclosure rules make it near impossible for individuals to predict what will happen. My best advice is to keep an eye on activist filings in the news for any companies that make products you care about. Corporate changes good for the retirement account often come at a price.