Activist Hedge Fund 'Leopards' Don't Easily Change Their Spots

by: Christopher Holt

If there is a patron saint of shareholder activism it’s probably Gordon Gekko, whose iconic “greed is good” shtick has launched a thousand activist hedge funds. Since he delivered that famous speech, Gekko had become the fourth richest fictional character in the world by 2008, with an estimated net worth of over $8 billion (ranking him ahead of the Monopoly guy, Thurston Howell III from Gilligan’s Island and even perennial bad-boy Jabba the Hutt).

So we were quite interested to see this recent study on hedge fund activism by Orly Sade of the Jerusalem School of Business, and Emanuel Zur of Baruch College at the City University of New York. The paper ponders whether activism is situational and ad hoc or, on the other hand, ingrained in the modus operandi of certain hedge funds. The answer is contained clearly in the paper’s title: “A leopard does not change his spots – evidence of activism in the hedge fund industry.”

True activism, of course, is a lot more than just taking a large stake in a company. Sade and Zur define it as a large stake (as evidenced by 13D filings), board appointments, and the threat of proxy fights. (Conducting unsolicited “Greed is Good” speeches at shareholders’ meetings was not explicitly measured by the study.)

After painstakingly collecting this data by hand, the duo combine these metrics into a “Yearly Relative Activism Index (YRAI)” that indicates the extent to which you might describe a fund as being truly an “activist” hedge fund – or just a hedge that dabbled in activism (but didn’t inhale).

A second index proposed by the authors provides comparison between hedge funds. The “Yearly Total Activism Index (YTAI)” measures the total amount of activism undertaken vs. other funds.

It turns out that an activist leopard can’t really change his spots – at least not that quickly. The duo finds that the correlation between level of activism in a given year and activism the next year (based on the YRAI) is 0.74. The relative amount of activism vs. peers also tends to be pretty persistent, with a 0.7 correlation between the YTAI in a given year and the YTAI the next year. So, once an activist, (almost) always an activist.

So which funds in the researchers’ sample had the highest and lowest YRAI score? The answer is contained in the chart below created with data from the paper.

As you might guess, funds with a high YRAI are also more likely to list what the authors call “proactively influenced future management decisions” in the “purpose” section of their 13D’s. In other words, persistent activists tend to repeat with a purpose.

Generally speaking, the paper finds that the more activist the hedge fund, the higher its management fees and incentive fees. But Sade and Zur found that the most significant fund characteristic in determining the level of activism is minimum investment.

The duo also found that activist hedge funds were more likely to be managed by an MBA from a top business school. But before you Ivy Leaguers out there get too excited about your activist fund start-up idea, note that activist funds were more likely to be managed by Top 30 schools (using Business Week’s rankings). The researchers found no significant correlation between activist managers and Ivy League graduates.

Clearly, hedge fund activism takes practice and experience. So it’s no surprise that an informational (alpha-generating) advantage can be secured by those, such as Gordon Gekko, who are dedicated adherents to its philosophy.

According to Forbes, Gekko dropped off the list of richest fictional characters in 2009 amid controversy and intrigue, not because activism isn’t an excellent strategy. Reports the magazine:

Forced to sell assets at fire-sale prices, currently thought to be hunkering down in Park Avenue apartment plotting legal defense. Wife Kate, heiress to the Wisher hotel fortune, granted quick divorce shortly after Gekko’s legal problems surfaced; rumored to get nothing under the terms of a punishing pre-nup.

“A leopard does not change his spots"- indeed!