For Activist Funds, a Long-Term Approach to Investing

Cevian Capital isn’t exactly a hedge fund, though it classifies itself that way in public filings.
It takes significant ownership stakes in companies for three to five years, but it isn’t really private equity, either.
Cevian, a $3.5 billion firm that is based in Europe with mostly American investors — Carl C. Icahn and the Florida Teachers Pension Fund among them — calls itself an “operational activist fund.” It is among a growing body of investors who eschew the limelight and push for longer-term operational changes at companies.
Funds like Cevian don’t grab headlines the way that investors like Mr. Icahn or William A. Ackman do, but some of them have done very well this year. Cevian is up 34 percent so far this year, after ending 2009 up about 35.7 percent. ValueAct Capital, based in San Francisco, which manages about $4.5 billion in assets, and Barington Companies Equity Partners are posting similar gains.
Activist funds are nothing new, of course. Where Cevian says it differs is its strategy, long lockup period and relatively low-profile approach and desire to get into the business and alter strategies and operations — not just shake up management.
About two-thirds of its roughly 150 investors are not allowed to withdraw their money for three to five years, a longer period than most activist hedge funds, Cevian says.
Cevian owns pieces of eight to 12 companies at a time, including Volvo and Demag Cranes of Germany.
“One great thing about the environment we’re in — everyone is super short-term focused,” said Harlan Zimmerman, a senior partner at Cevian who is based in London “They’re just reading the headlines and moving as quickly as possible.”
Other activist funds agree that with pressures on funds to produce short-term results or risk having their investors ask for the money back, those that can stay in for the long term can have a competitive advantage.
“It’s been the perfect environment for us,” said Jeffrey Ubben, founder of ValueAct. “I don’t think a lot of activist investors do what we do, because they either don’t want to get illiquid or don’t want to go as long.”
But hedge funds, even activist funds, face a challenge in being able to gain access to a stable capital base.
“That’s where everybody would like to be in the activist world, but it’s a tough balance,” said Damien Park, managing director of Hedge Fund Solutions. Sometimes managers have to give up their fee structure, he said, in exchange for longer lockup for capital.

Still, it is difficult to persuade investors to agree to long-term commitments. Many of them want the ability to withdraw money from hedge funds when there is turmoil. During the financial crisis, a number of investors found themselves unable to take out money.
The influential CFA Institute suggested recently that endowments and foundations, which provide a substantial portion of hedge funds’ assets, consider limiting or restricting investments in hedge funds that tie up capital.
The Investment Management Code of Conduct for Endowments, Foundations and Charitable Organizations warned that “such arrangements may affect future members’ ability to effectively manage the financial resources to meet the funding needs of the organization.”
To avoid the difficulty of long lockups, firms have adjusted. More hedge funds are creating so-called special purpose vehicles, highly specific investments tailored to just one acquisition, say lawyers who work with hedge funds.
“It’s happening more than it has in previous years,” said Marc Weingarten, a partner at the law firm Schulte Roth & Zabel. “Investors are more willing to lock up for that kind of play with the right manager.”
Other hedge funds are trying different approaches.
Philip Falcone, the embattled manager of the hedge fund Harbinger Capital Partners, bought a public shell company to avoid the whims of flighty investors. With the stable capital base of a public company, he doesn’t have to worry about redemptions, which can force managers to sell investments on the cheap.
Cevian likes to distinguish itself from other activists in the field by emphasizing its long-term commitment to the companies it invests in. Cevian executives typically spend six to seven months examining a company before they invest, speaking with managers, competitors, workers, suppliers and even those who have left the company.
Of course, they can also employ the same set of tools available to other activists, like layoffs, sales and public fights, and have not always been welcome among their target companies.
The downside is that their strategy is volatile and highly concentrated; in short, like most activists, they’re not very hedged.
“If you’re going on the board,” Mr. Zimmerman said, “you can’t be shorting companies.”
The coming year looks to be a good one for activist investors. A recent survey conducted by Schulte Roth and Mergermarket found that respondents expected shareholder activism to increase over the next 12 months.
That sort of activism stands to benefit operational activists as well as those who focus more on the balance sheet end of the spectrum.
Still, some analysts think that operational activists have a more sustainable model than hedge funds that agitate for change but are less inclined to go beyond financial engineering.
“Companies are getting more and more sophisticated about how to deal with activists, and so the number of sitting ducks is decreasing,’ said Michael Armstrong, an analyst at Monitor Group who studies activist investors. “If you really are going to create value going forward, you have to find a way of creating value above and beyond just agitating for change.”
That’s not to say that the more conventional activists won’t do well for themselves, and potentially for shareholders.
“There is fair amount of research that suggests the existence of a large, knowledgeable shareholder in the capital structure of the company has great benefits to smaller shareholders,” said William N. Goetzmann, professor of finance at Yale University School of Management. “Having an activist investor on your side by owning the same class of shares that you own — that’s a good thing.”

http://dealbook.nytimes.com/2010/12/20/for-activist-funds-a-long-term-approach-to-investing/?partner=rss&emc=rss

Indexes beat most actively managed funds, S&P says

Investors in actively managed mutual funds the last five years have reason to wonder what they've been paying for: A new study from Standard & Poor's finds that 70% of large-cap fund managers who use the S&P 500 as a benchmark for comparison have failed to match the performance of the index over that time.

That's double bad news, given that the index was down 19% in the five years that ended Dec. 31. The failure of active management is replicated across almost all categories, not only U.S. stock funds but also bond funds and even emerging-markets funds. What's more, those numbers are similar to the previous five-year cycle.

From the close of Dec. 31, 2003 to Dec. 31, 2008, the S&P 500 ($SPX) dropped 18.8% -- but that was still enough to beat 71.9% of U.S. actively managed large cap funds, according to S&P Index Services.

"We consistently see that once you extend time horizons to five years, the majority of active managers are behind their benchmarks," said Srikant Dash, global head of research and design at S&P.

"We're not saying people should be 100% in indexes," said Dash. "Most people don't want to settle for average returns, they want top quartile returns. But it's important to understand the risks and to know your odds of beating the index."

Things were even worse for small-cap active managers, said Dash. The S&P SmallCap 600 (SML) outperformed 85.5% of small-cap funds. That index was down 0.6% over the five years to Dec. 31.

"There's a prevailing myth that small cap is more of an active managers' market because they can find the little nuggets, but there's a lot to be questioned," said Dash. "People need to rethink the belief that the small-cap market is inefficient and needs active management."

Even among emerging-markets funds, for many years the darlings of mutual fund investors, most lagged their comparable S&P index. The S&P/IFC Emerging Markets Index bested 89.8% of actively managed emerging-markets stock funds in the past five years.

Actively managed bond funds also struggled. Except for high-yield funds, at least 80% of bond funds lagged their comparable benchmarks across all categories, said Dash. Because of liquidity issues, bond benchmarks are not as easy to replicate by index funds.

More evidence

The numbers from S&P are supported by research from Morningstar Inc.

Morningstar found that across its nine U.S. stock styles the average mutual fund beat its respective S&P index in only two style categories, and outperformed Russell indexes and Morningstar indexes in just three style categories over the five years through March 31. In all but one case of average fund outperformance, the difference was less than one percentage point.

"Index investing has proved its worth as a simple, no-nonsense, cheap and tax-efficient way of investing," said Dan Culloton, associate director of fund analysis at Morningstar.

But Culloton said that despite the numbers investors shouldn't ignore active management.

"There are going to be managers that beat their benchmarks," he said. "It's just hard to identify those managers or the years they'll do it."

Morningstar did find that the average fund beat all but one of its category Russell and Morningstar indexes over 10 years. It also beat the S&P indexes in five of the nine categories.

But the problem for investors is that while the average fund performance was better than most indexes, overall outperformance was still low. S&P doesn't calculate 10-year comparisons, but while 71.9% of large-cap funds lagged the S&P 500 in the past five years, 53% of large-cap funds lagged the index in the previous five years.

Five steps to success

Culloton said that when it comes to picking the right, index-beating fund, investors can try to "stack the odds in their favor" by following five steps before choosing a fund, most importantly knowing their fees.

"Funds in the lower fifth of a category for fees will have a significant head start," for returns, he said.

A fund manager's experience -- Culloton said a track record of at least 10 years is needed to determine whether returns are due to skill or luck -- how closely a fund's portfolio sticks to its strategy, and stewardship of a fund are also important.

Stewardship takes into account how a fund is run in the interests of shareholders, said Culloton, and one good measure is how much money managers invest in their own funds.

The least important step is focus on a fund's performance. This should ideally consider long-term returns through different cycles.

"That's a lot of work," for many investors, said Culloton. "That's why index investing has so much appeal...you have the peace of mind that you'll at least get market returns minus the fund's price."

http://www.filife.com/stories/indexes-beat-most-actively-managed-funds-sp-says