Are Activist Hedge Fund Managers Really Running the Show on Wall Street?

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The activist investor has been around forever on Wall Street. For years the portfolio managers and equity strategist at the big mutual fund companies were the ones that really could drive change at a company. When Peter Lynch was running the show at Fidelity in the 1980s and 1990s, his power, and the purchasing power of Fidelity, was so great that they often could dictate everything from replacing a CEO to securing a board seat.

The days of the mutual funds calling the shots are not over, but certainly diminished. The proliferation of fund families, as well as an extended 13-year secular bear market, put a large dent in their assets under management, especially for their equity funds that were large buyers of stock. Somebody though has found a place at the table, and sometimes it is as a guest that many companies wish had no invitation.

Once considered purveyors of a niche investment strategy, hedge fund activist investors have leapt onto the big stage as hedge funds wage bolder battles against ever-bigger corporate targets like Apple Inc. (NASDAQ: AAPL), often leaving other executives wondering if they could be next. Unlike the activist crowd before them who were looking for aggressive takeovers for quick gains, the new breed often agitates for long-term change, shifts in business models and strategies, even a complete removal of a company’s board.

With large returns and a slew of new money coming into funds at a rate not seen in seven years, activist investors, as defined by industry experts like Hedge Fund Research, have a gigantic war chest, as much as $85 billion, with which to wage their battles. That is more than double the funds they had just four short years ago.

So who is really running the show on Wall Street? Carl Icahn has not only battled companies, he has battled other activist investors. His classic verbal joust on CNBC with Pershing Square founder and leader Bill Ackman was the stuff of legends. They argued over the merits of the business model at Herbalife Ltd. (NYSE: HLF), with Ackman maintaining it was nothing more than an elaborate Ponzi scheme that he was short. Icahn argued that the business had been solid for years and many other successful companies had used multilevel marketing.

Ackman recently lost nearly $500 million in his efforts to bring systemic change to old line retailer J.C. Penney Co. Inc. (NYSE: JCP). He strayed from their long-held low-cost and bargain advertising structure and installed former Apple executive Ron Johnson to try and make J.C. Penney hip. That did not work. Most likely it set the company back so far it may never recover. Which brings up the point, do ego-driven activist investors ultimately hurt or help businesses in their quest for the gigantic gain for their hedge funds?

J.C. Penney was Ackman’s second big retail play and his second huge loss. Ackman invested $2 billion in Target Corp. (NYSE: TGT) in 2007, and by 2009 the investment had lost 90% of its value. Along the way he waged a huge and expensive proxy fight with the company and tried to fundamentally change its long-standing business practices. “One of the complaints directed at Ackman was that at a very difficult time for the company [in a recession], he was distracting management from doing what they should be doing,” said Ian Maitland, a professor of management at the University of Minnesota’s Carlson School of Management. Which again poses the question, is this good or bad for publicly traded companies?

Often activist investors can breath new life into a moribund company. Third Point’s Dan Loeb used extraordinary efforts to resurrect Yahoo! Inc. (NASDAQ: YHOO), which proved hugely successful for his hedge fund and investors. It also helped Yahoo! return to a much brighter future. Loeb successfully ended the short-lived tenure of Scott Thompson as CEO after finding some discrepancies and inconsistencies on his executive resume. He was then instrumental in hiring long-time Google Inc. (NASDAQ: GOOG) executive Marissa Mayer to the CEO position. Since Mayer took over, Yahoo! the stock is up 86%, a huge win for Yahoo! shareholders. In July, Loeb sold 40 million shares back to Yahoo!, and now he is busy with a 6.9% stake in the Japanese electronics company Sony Corp. (NYSE: SNE). He has urged it to consider a breakup that would entail spinning out its entertainment unit in a public offering.

Regardless of the outcome, good or bad, activist hedge funds will continue to play a huge part in companies in which they have taken a large stake. Warren Buffett has not only played large roles in companies he has a large stake in, he also was the lender of last resort to Wall Street banks back in 2008 when a financial collapse seemed a possibility. A noble, yet cunning move not seen since J.P. Morgan himself, along with other bankers of the time, helped keep the panic of 1907 from turning into a total calamity. One thing is for sure, if money is there to be made, the activist hedge fund manager will not be far behind.

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