The future of shareholder activism will not be driven by hedge funds


Shareholder activism is about to change dramatically as investors move away from the classic approach of targeting improvements in a single company and instead work to benefit all of their portfolios. But activist hedge funds that have historically led proxy campaigns may not be in the best position to lead the charge, new research shows.

Currently, there are two main types of shareholder activism: the more traditional company-specific activism, which targets a specific company and requires change to benefit that company, and systemic risk activism, which aims to reduce systemic risk in the wider market. According to John Coffee, a professor at Columbia University School of Law, business-specific activism may be phased out by systemic activism in the years to come, as investors focus on issues such as climate change, diversity and inclusion. However, for everyone except the three major index managers – State Street, BlackRock and Vanguard – systemic risk campaigns can be a losing proposition.

“If you are running a proxy campaign, asking the shareholders of the company to vote and forcing the company to reduce its core business to high carbon fuels, you are actually running a campaign to lower the share price. of the company, “said Coffee Raconté Institutional investor. “There is a dilemma here in trying to run a campaign that benefits the portfolio, but hurts the shares of the target company. “

According to Coffee, there is a stronger investment case for systemic risk activism in companies like State Street, BlackRock and Vanguard, which have large swathes of the market.

“Only three of them hold 23.5% of the S&P 500. If you use some of the larger pension funds, you have six or seven institutions that hold the majority of the index,” he said. declared. “This is a new change, and it means these funds don’t just have a portfolio; they own the whole market.

In his new article, Coffee poses the question of who will lead systematic risk management campaigns, noting that institutions that conduct such campaigns are often vulnerable to large losses when the target company’s stock price s ‘collapse – something that would disproportionately harm activist hedge funds as due to their smaller portfolios. For example, while an index fund can hold stocks in thousands of companies, a hedge fund or mutual fund can only hold 10.

In this new environment, Coffee said, activist hedge funds are inadequate and largely incapable of steering activism against systemic risk. Since hedge fund and mutual fund portfolios are not as diversified as index funds, if any of their stocks collapse, their portfolios could collapse along with it. Additionally, smaller funds may not have the capacity to fund proxy campaigns, which can be costly, especially with the additional loss in the market value of the targeted company.

As an example, Coffee said that an investor looking to increase the value of their entire portfolio could realistically launch an activist effort that would cause an oil company like Exxon Mobile to lose 10% of its value. If the move causes another 10,000 exposures in the portfolio to gain 1%, those gains will far outweigh the loss of Exxon. For the Big Three, this type of compromise is possible.

“But a hedge fund can’t do that,” he said. “A portfolio of just 13 stocks – mostly high tech – won’t allow you to realize this market-wide improvement advantage.”

Coffee isn’t the first to draw attention to this new direction in activist investing, and he doesn’t believe he will be the last. For now, Coffee expects systematic risk management campaigns and business-specific activism to continue to coexist.

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