Activist activity, which has been defined as an equity investor asserting control and influence for the benefit of equity investors, is not a new phenomenon but its pace has accelerated in recent years. Activist activity has increased 26 percent from last year’s first quarter.

Unintended Consequences

While this activity has been largely regarded as positive for shareholders, the practice has unintended consequences for the corporation targeted, which invariably affects shareholders of all stripes. This is largely because of the nature of the companies targeted, which are typically perceived as weak or deficient and an activist hedge fund can leverage its stake to coerce management to take corrective action. However, it must be noted that activist hedge funds are primarily concerned with realizing a profit and the fact that a company is well-run will not deter it from pursuing an activist role. Naturally, the unintended consequences vary, based on the objectives of the activist fund.

One study sponsored by the Kellogg School of Management suggests that when the goal is to force the target to accept acquisition or increase dividends, lenders charge higher rates. Alternatively, when the activist’s objective is focused on stopping a takeover or blocking efforts to topple a well-established CEO, lenders typically offer more favorable terms.

Yet another study by Klein and Zur (2011) finds that on balance, activist intervention results in depressed bond ratings and returns because the effect of the intervention transfers wealth from bondholders to shareholders.

Additional Consequences

An argument can be made that activist hedge funds do not have the long term interests of the company on the radar. Rather, objectives target short term gains in time frames of less than a couple of years which can be to the detriment of real shareholder value as managers tend to refocus on short term gains in stock price.

Others believe that activist hedge funds that press for corporate share buybacks are actually engaging in a form of stock manipulation which bleeds capital from the corporation that might be better employed in creating value for the customer through research and development.

Still others have the view that activist hedge funds are too much of a distraction for senior management, diverting attention away from the actual management of the company.

Disruption Is Inevitable

One consequence of activist intervention has come from an unlikely source—rating agencies. For example, Casablanca Capital recently succeeded in seating six members on the board of Cliff Resources and, as a result, Moody’s cut the company’s rating from investment grade to speculative.

Clearly, activist hedge funds are disruptive. Whether or not this disruption is universally positive or negative will be the subject of debate for the foreseeable future. The truth is likely somewhere in between those two extremes.

Activist hedge funds have been around for many years, but since the implementation of Rule 10b-18 in 1982, the practice has become more prevalent especially as it relates to stock buybacks that are not in excess of twenty-five percent of the stock’s average daily trading volume (ADTV). Activists must recognize the potential for unintended consequences and act prudently while engaging in activist investing.



If there is one point that we can agree on, no study of hedge fund size relative to hedge fund performance has been conducted that is capable of defending its conclusions effectively against all-comers. The nature of the industry, in terms of its diverse strategies, varying degrees of management competency and numberless external market forces, precludes the possibility of bullet-proof conclusions.

There Are Things We Know  and  Things We Don’t Know

We know that no consensus definition exists for small and large. As a result, no valid conclusions can be drawn by comparing studies with differing definitions. For example, if study “A” caps small hedge funds at $500 million and study “B” caps them at $100 million; significant overlap exists between small and large funds rendering any consolidation of data questionable.

Similarly, study “C” may confine comparisons to a finite universe of strategies, while study “D” adopts a macro view that encompasses hedge funds which ply an infinite variety of strategies. In both examples, attempts at comparing the conclusions are, by definition, flawed.

Taking the argument a step further, imagine that studies being compared were conducted in different years. Comparing a study concluded in 2009 to a study concluded in 2012 would necessarily yield disparate results due to the incongruity of market forces.

We know that we cannot predict how political climate will exert its influence on the direction of regulation and legislation and these forces will necessarily impact the performance of hedge funds regardless of size. Small hedge funds may be able to adapt more readily than large funds or, conversely, large funds may have superior resources allowing them to adapt in a manner that eludes smaller hedge funds.  A recent example of one such change is lifting the general solicitation ban. Future changes may include redefining the parameters which constitute a qualified investor.

We do not know what innovative financial products are on the horizon and we certainly don’t know if they will be more or less suited to the small, medium or large hedge fund. We don’t know at this point what defines a small, medium or large hedge fund.

There Are also Unknown Unknowns

The significant factors affecting hedge fund performance may be unknown unknowns! How are potential investors supposed to govern themselves in this environment? While there is no clear-cut answer, the conclusions reached in existing studies trend in favor of the extremes. That is small hedge funds on one end and large hedge funds on the other, with those in the middle being the poorest performers.

Beyond the Question of Size

Factors other than size are key drivers in rates of return. Investors must look beyond size when choosing a hedge fund. Important factors include:

  • The proven track record of the hedge fund manager
  • The fund’s investment strategy
  • Management and performance fees

The means of choosing a hedge fund hasn’t been distilled into anything resembling a scientific formula. Potential investors will continue to rely on their own good judgment, due diligence and gut instinct for the foreseeable future.


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