Activist Investors Cannot Generate Significant, Long-Term Gains
first published in The Street | May 18, 2016

Can activist investors deliver the outsized returns that their actions and rhetoric seem to promise?

TheStreet recently published an interesting article about the potential impact of activist hedge fund managers and the failure of mega mergers — sometimes potentially good deals.

But the article only touches on part of the dilemma of the whole activist strategy and mania. ‎While activism becomes popular at specific times, particularly in bull markets, the strategy probably cannot generate long term alpha or out performance.

The central problem is that an activist has to have a large position in a stock to have an impact. This is fine in a bull market as stock prices rise. Indeed, it is probable that a large amount of the stock uplift in a position held by an activist has nothing to do with the activism; rather, it stems from buying into a rising market‎. Naturally, an activist’s buying helps with demand for the stock.

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But if the wider market declines, the activists’ ‘activism’ tends to become increasingly irrelevant to the direction of the stock (if it ever really was in the first place). In a sudden bear market, activists tend to find they have large concentrated positions that often become highly illiquid — or at least can only be sold down at a significant discount to their then market price.

This phenomena wiped out various activists with limited experience in the last credit crisis. They included Aticus Capital, the fund of Timothy Barakett and Nathan Rothschild.

Curiously enough, these types of financial models are not uncommon. There are numerous industries that make a significant ROIC during good times, only systematically to wipe out years of historic retained profits in bad times.

It is true, for example, of many aviation lessors. These companies are betting not just on aircraft lease rentals, but more importantly on the residual value of aircraft at the end of say a typical 5-year lease. If aircraft values have gone up during that lease period (usually because of benign economic conditions) the lessors make out like bandits.