Only three years ago the talk at Super Return, the private equity industry’s best-attended conference, was all about the threat of hedge funds to the industry; competing for private equity assets and funds, and being an uncertain bedfellow in the debt ladder. Last year it was all about how hedge funds were welcome partners for private equity, putting businesses into play and being the provider of useful strategic stakes as platforms for take-privates. This year we’ve moved on again, with hedge funds seemingly preferring to engineer majority control of assets and using their stealthily built up stakes to act as a block to take-privates. Hedge funds bizarrely seem to have become the public company fund manager’s friends.
Historically, hedge funds have lived up to their stereotyped ‘bad boy’ image. Proving the enabling lever to many a hostile bidder, they have used their position on a target’s share register to enable hostile bids. Cast your mind back a couple of years to Old Mutual’s bid for Skandia. It is not surprising then that public companies have been somewhat hesitant to have hedge funds on their books. With their new tactics, seemingly swapping allegiance and siding with management teams in rebutting unwelcome offers, should public company fund managers and company managers, cognisant of their fiduciary duties, welcome these often more tricksy and challenging shareholders?
Recent evidence suggests they might. Just last month we saw hedge funds Artisan, Boussard & Gavaudan, Jana, Polygon and Seneca reject
So what’s in it for the hedge funds and what’s changed? They have apparently reverted to a form of value investing, taking positions in situations where there may be a change of control but where the principal investment driver is that the hedge fund sees a re-rating of a stock over time. What has caused this change in their investment approach? Are the options available to them in an increasingly competitive market now sufficiently limited that they have reverted to being value investors rather than market anomaly arbitrageurs? There have been a handful of cases, for example
The specific reason is undoubtedly secondary to the effect this change in approach is having. Public company investors are finding, at least for the moment, that having a stake-holding hedge fund on the share register is an asset rather than a cause for concern, both acting as an active deterrent to cheap bidders and, in the event of an accepted offer, acting in effect as a return amplifier. For management, their appearance on the register may be more of an issue given that the focus for the hedge fund is going to be value creation/enhancement through some sort of proactivity.
What should a pension fund or life company investor make of this? Private equity has its tribulations, accused on all sides of opportunism in targeting companies the market cannot seem to love and then subsequently stripping out valuable assets and weakening work forces before exiting in short order, accusations they would certainly and sensibly rebut. But what to think when a hedge fund not only helps, if an exit is inevitable, to secure a better deal, but then the hedge investor stays in for the ride, working alongside the ‘rapacious’ private equity investors as they execute their ‘amoral plans’?
Perhaps the sensible conclusion is that both sets of investors, private equity and hedge funds, are in fact identifying value that simply cannot be extracted as public companies or at least not in a viable time frame. Perhaps it is time to accept that all investors; pension fund, life fund, hedge fund or private equity fund, have a role to play in a changing world where the governance of corporates will be determined by free markets and where money will simply follow value as it always has.
Finally, what are we to make of the increasing calls for greater transparency and hedge funds’ reluctance to meet them? Current SEC disclosure rules prohibit hedge funds from any form of advertising. If they were to openly discuss their activities this would be considered a breach of such rules. Hedge funds are in a no-win situation: if they give in to the calls for transparency, their lawyers advise them that they risk breaking the SEC’s Reg D, if they remain silent they are accused of being secretive.The SEC could change its rules and accommodate a more open policy, but until it does so hedge funds are caught in a bind. Perhaps the industry, and the media in particular, should be less wary of them, treating them with the same regard and caution as they would any other investor and judge them instead on their merits and their results. One thing is certain, we will be seeing a lot more of them in the future.