The main purpose of setting up a hedge fund is to make money notwithstanding market conditions. Ever since hedge funds demonstrated the ability to fatten the bottom line, some ventured into a larger arena. The funds transformed into what is known today as the activist hedge fund.
This time around, the object is to invest large sums of capital in a company or ongoing business concern. However, the investment comes with a stipulation. The activist hedge fund will take an active management role and be involved in the company’s decision making process.
A long-term objective
Activist hedge funds are skewed towards a private equity approach but with long-term goals. There is fondness to seek out companies that are unable to exploit their full potential and maximize shareholder value.
Their solution is to pump in huge investments and expense them out as incentives to the management team. The incentives are meant to bloat compensation and add more perks while subduing free cash flow.
The workings of an activist hedge fund are somewhat radical in nature. With a huge equity and incentives laid down, there is pressure on the management to perform and deliver. They have the power to institute drastic changes within the company.
Activist hedge funds can alter corporate policies, change financing structures, and implement cost-cutting measures. They can also effect or introduce policies that are non-financial.
A stark difference from typical hedge funds
Hedge funds are the top-of-mind choice of sophisticated and high-net-worth individuals because it offers an ideal diversified portfolio. Activist hedge funds have a less diversified portfolio.
Activist hedge funds have the reputation of encroaching into public-listed companies. They take large positions by purchasing substantial shares. That would give them the power to force management to shape up. Management has no recourse but to abide because they work to please shareholders.
Some founders of activist hedge funds would demand board seats or remove those that are opposed to the intrusion or changes. Activist hedge funds keep close watch over company operations. They require higher accountability from senior officers and managers.
When the company finally performs as anticipated, the activists partake of the bigger slice of the pie. Usually, the expected outcome or turnaround doesn’t happen in a short period. Other companies might take longer to assimilate to the major changes. But to a certain extent, the entry of the activist hedge fund is the needed boost or motivation to turn things around.
One interesting observation is that activist hedge funds unlock the real value of struggling companies, private or public. They are credited with bringing in weighty gains to their investors. Even if they hold non-controlling stakes and keep the holdings longer, their presence alone is enough for companies to experience growth.
But the key takeaway from having a lurking activist hedge fund is its strong suit to improve corporate governance and subsequently increase shareholder value. Everybody wins.