Can Investing With Activist Investors Produce Alpha?

by: Connor Gustafson

Summary

Investing the day after an activist investor announces a large stake can produce alpha.

The strategy over 34 activist stakes generated 18.12% per year, nearly 4% more than the S&P 500.

We can replicate the process through 13F and 13D filings.

The hedge fund industry's current AUM is about 2.5 trillion. Of that number, about half is allocated to public equity and an even smaller number is dedicated to activist investment. So why do we care about activist investment so much? Perhaps it is American sensationalism or maybe we just like a good story, but whatever it is, every day we hear from the likes of Carl Icahn or Bill Ackman on CNBC, or in another media outlet. These brilliant and powerful investors outline their plan to unlock value in company XYZ, as if they are screaming from the top of the mountain for all to hear, through share buybacks, managerial shakeups, spin-offs, or other strategic planning and then back up their story with war chests full of their investors' capital. As average investors, we are intrigued to see what the pros are doing, but we do not have access to these investors' funds. So, how do we join in on the fun with these modern-day yodelers? We follow them closely and invest with them. But will this strategy generate alpha? The following study will provide the conclusion.

I looked at 34 previous activist investments from some of the biggest players in the business. I took the share price of the day after the activist announced a position and marked this as a buy. We can follow activist activity through 13F filings online and through 13D filings in Barron's. I then compared it to the day after the activist either won or lost proxy vote, or exited the position. The study will focus on long only as many average investors do not short or have the capability to do so. For example, we would buy Valeant Pharmaceuticals (VRX) the day after Bill Ackman announces a hostile takeout bid for Allergan (NYSE:AGN), and then sell Valeant Pharmaceuticals the day Allergan rejected the offer and took the actavist's bid. I then compared the returns of the individual stock to the market return of the S&P 500 over that time period to find if investing alongside the most famous hedgies in the world can generate alpha. Please read through for the data and the conclusion.

Company

Activist Activity

Date Bought

Date Sold

Total Time held

Share Price Buy

Share Price Sell

P/L

S&P 500 Return

Beta of Stock

Reason for Activism

Pershing Square Capital Management

Allergan and Valeant

4/21/2014

10/18/2014

0.49

135

142

5.19%

0.79%

0.46

Buy out of Allergan. I calculated until the failure date to purchase Allergan. Pershing Square still owns a large portion.

Bill Ackman

J.C. Penney (NYSE:JCP)

10/9/2010

9/2/2013

2.90

34

14.27

-58.03%

41.00%

1.34

Shake up of company. Appointment of Ron Johnson to CEO. Board Member. Failure.

Air Products and Chemicals (NYSE:APD)

9/1/2013

6/26/2015

1.82

109

143.83

39.95%

28.21%

1.42

Shake up of management, mainly CEO.

Canadian Pacific Railway (NYSE:CP)

10/31/2011

6/26/2015

3.66

61

162

167.67%

67.75%

1.07

Shake up of management.

Trian Partners

Nelson Peltz

DuPont (DD)

7/18/2013

5/18/2015

1.83

57

70

27.81%

25.83%

Spin-off of chemical units, break up of company.

Tiffany (NYSE:TIF)

2/27/2007

9/30/2011

4.59

45

63

48.00%

-18.44%

1.93

Management shakeup. Undervalued.

Wendy's (NYSE:WEN)

5/3/2008

6/26/2015

7.15

7.35

11.4

66.10%

51.43%

0.51

Management shakeup. Undervalued.

Icahn Enterprises

Carl Icahn

Apple (NASDAQ:AAPL)

10/25/2013

6/26/2015

1.67

75

127.5

72.50%

19.47%

1.07

Share buyback. Undervaluation.

Dell

3/7/2013

9/10/2013

0.51

14

13.85

0.43%

8.56%

--

Transocean (NYSE:RIG)

1/15/2013

6/26/2015

2.45

56.76

16

-62.81%

42.71%

1.6

Increase dividend. Undervalued

Navistar (NYSE:NAV)

11/20/2011

6/26/2015

3.60

38

22.75

-40.13%

81.44%

3.12

Restructuring. Management changes

Starboard Value

Jeffrey Smith

Darden (NYSE:DRI)

12/23/2013

6/26/2015

1.51

54.5

71.83

37.80%

15.01%

0.69

Restructuring, reevaluate strategic positioning, and managerial changes.

MeadWestvaco (MWV)

6/3/2014

6/26/2015

1.06

43.63

47.89

17.76%

9.25%

0.55

Spin-off of specialty chemicals unit, undervalued, and sale of company.

Brink's (NYSE:BCO)

5/4/2015

6/26/2015

0.14

30.61

30.23

-1.24%

-58.00%

1.72

No plans as of yet.

Office Depot (NYSE:ODP)

8/8/2013

6/26/2015

1.88

4.2

8.89

111.67%

23.85%

2.75

Push for OfficeMax deal and sale of company to Staples (NASDAQ:SPLS).

AOL (NYSE:AOL)

12/22/2011

6/15/2012

0.48

15.5

25.5

64.52%

6.13%

--

Managerial shakeup. Loss in proxy vote.

Smithfield

6/18/2013

9/26/2013

0.27

33.11

33.99

2.66%

4.28%

--

Attempted breakup of company and sale. Failure and Chinese takeover by Shanghui took place at 34 a share.

Gamco

Mario Gabelli

Brink's

12/16/2014

6/26/2015

0.53

22.92

30.17

32.38%

6.57%

1.72

Gabelli claims that Brink's is undervalued and should be private.

Griffin Land (NASDAQ:GRIF)

11/26/2013

6/26/2015

1.58

33

32.26

-1.49%

16.62%

--

Gabelli wants GRIF to examine itself as a REIT or MLP.

Superior Industries (NYSE:SUP)

11/26/2013

6/26/2015

1.58

18.9

18.69

4.89%

16.62%

0.93

Gabelli wants a share repurchase program.

Third Point

Dan Loeb

Yahoo (YHOO)

10/3/2011

7/29/2013

1.82

15.47

27.65

78.73%

49.66%

1.46

Proxy vote success and shake up of board. Marissa Meyer new CEO.

Jana Partners

Barry Rosenstein

McGraw-Hill (MHFI)

8/2/2011

9/12/2011

0.11

37.77

40.51

7.25%

-7.78%

1.64

Breakup of company.

Marathon Petroleum (NYSE:MPC)

1/21/2012

2/20/2012

0.08

31.24

35

12.04%

4.15%

1.02

Operational changes to company and potential breakup.

Agrium (AGU)

10/20/2012

3/5/2014

1.38

68.7

93.56

43.19%

30.69%

0.87

Return of capital to shareholders and split business.

Ashland (NYSE:ASH)

4/28/2013

5/13/2015

2.04

86

128.59

52.52%

31.81%

0.71

Restructuring, recapitalizations, spin-offs.

Safeway (NYSE:SWY)

8/20/2014

1/29/2015

0.44

24

35.1

46.25%

1.45%

--

Merger arb. and restructuring.

QEP Resources (NYSE:QEP)

10/22/2013

10/16/2014

0.98

32.9

23.33

-29.09%

6.66%

1.23

Midstream unit breakup.

Elliot Management

Paul Singer

Hess (NYSE:HES)

12/1/2012

6/26/2015

2.57

50

68.48

40.96%

49.16%

1.78

Managerial shake up and capital allocation changes.

ValueAct

Jeffrey Ubben

Adobe (NASDAQ:ADBE)

12/27/2011

1/13/2015

3.04

38.13

74.04

98.18%

58.32%

1.31

Managerial shake up.

Moody's (NYSE:MCO)

7/20/2011

6/26/2015

3.93

35.61

110.2

213.46%

56.30%

1.36

Managerial shake up.

Motorola

7/17/2011

6/26/2015

3.94

46.5

58.1

33.95%

56.30%

0.59

Work with management to unlock value.

Relational

Ralph Whitworth

Occidental (NYSE:OXY)

8/3/2010

5/3/2013

2.75

72.35

85.58

27.29%

43.22%

1.17

Removal of CEO, Ray Irani.

Clinton Group

Greg Taxin

Violin Memory (NYSE:VMEM)

12/19/2013

10/16/2014

0.83

4

4.16

4.00%

2.44%

--

Sale of company.

(Taxin leaves Clinton Group on 10/16/14)

XenoPort (NASDAQ:XNPT)

10/15/2013

10/16/2014

1.00

6.02

6.41

6.48%

8.20%

--

Replace CEO.

Total

34

Averages:

1.90

34.44%

26.93%

1.31

Return Per Year:

18.12%

14.17%

Based on the data set, we see that following activist hedge funds does produce alpha. Over the course of the average investment of 1.90 years, the activist strategy returns an average of 18.12% per year versus the S&P 500 return of 14.17% over that time period. However, not taken into account are the trading costs of the transactions or the value of your time following the hedge fund activists. One important aspect to consider is that the average betas of the stocks are about 1.31. The higher return of the activist hedge fund strategy could just be a product of taking on more volatility to the market and may not represent any innate stock-picking ability. Another aspect to consider as an investor is whether or not activists add value (if you care about such a thing), as this can be widely debated. Did Valeant or Allergan add value when Ackman attempted to play matchmaker? Probably not, but there was still money to be made.

Another important aspect to consider is when this study was done. All of the activist investments were done during the recent bull market that has generated returns of over 200% in six years. It has been shown that activists can even beat the market in periods of rapid asset appreciation, so I would hypothesize that a strategy of following activist investors would also be successful in a sideways or bear market. However, I do not have the empirical research to prove such a claim as the proliferation of activist investors has only just begun. This can provide a potential issue. As activist investors prove to make a lot of money and beat the market, we will see an influx of assets to this strategy that could dull down returns. I believe that this will not be an issue as you should always follow the big guys that have been doing this type of investing for a long time, for example, Bill Ackman, Dan Loeb, Mario Gabelli, Carl Icahn, Jeffrey Smith, Nelson Peltz, and Barry Rosenstein.

There is one takeaway that is important to note after conducting this study. Picking activist investors are just like picking stocks, some are good during some times, and some not. Not all activist investors will always lead to gains every time, just like stocks. My advice is to evaluate an activist pick and only if you like the stock independently of the activist involvement, then buy in, otherwise you are better off in an index, like the SPY or MDY. If you do not know why you own something, don't own it. Do your own work, but you can use these guys as idea generators. Do not follow Carl Icahn blindly into battle, even if he seems to be on a hot streak, because the market humbles everyone, even Mr. Icahn.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.