What Is an Activist Investor?

What Is an Activist Investor?

Let me explain what an activist investor is. I'm talking about a shareholder who grabs a significant minority stake in a publicly traded company to shake things up in how it's managed and operated.

As an activist investor, usually a specialized hedge fund, you buy that stake to change the company's direction. Your goals could be straightforward, like giving advice to management, or bold, like pushing for the company's sale, breaking it up, restructuring it, or even replacing the entire board of directors.

You need to understand that this differs from private equity firms. Those guys buy and overhaul companies to flip them for profit. Activist investors like me rarely go for full or majority ownership. Instead, we rely on public statements and private talks to rally other shareholders and insiders. If that doesn't work, we might launch a proxy contest to elect new directors and force the changes we want.

Key Takeaways

Here's what you should remember: Activist investors purchase minority stakes in public companies to alter their operations. If management doesn't listen, they can start a proxy fight to gain board seats. Some hedge funds focus solely on this, while institutional investors dip in occasionally. Their activism might aim to boost shareholder value or push for social responsibilities. Also, the SEC is proposing stricter disclosure rules that critics say could kill off activism by making it unprofitable.

Understanding Activist Investors

You might hear activist investors called shareholder activists, a term that also covers people pushing companies to better working conditions for overseas workers or supporting boards fighting climate change.

But in many cases, these campaigns are all about maximizing shareholder value, and hedge funds specializing in this lead the charge. They bring a mix of public pressure, behind-the-scenes lobbying, and business know-how.

Unlike public pension funds or mutual funds that sometimes get activist after holding a bad investment for years, activist hedge funds buy into underperforming companies right before demanding change. They hold concentrated stakes, often boosted by derivatives like options, to cover campaign costs and profit from turnarounds and stock price jumps.

These hedge funds are more aggressive than institutional investors, using tactics like harsh letters to management, negative public reports, or proxy fights to remove directors.

Tip on the Agency Problem

I've seen the rise of activist investors described as a smart market fix for the agency problem. That's when company managers, as agents, can line their own pockets at the expense of shareholders, who are spread out and lack strong ways to protect their interests.

How Activist Investors Make Their Case

When you're an activist investor, you often kick off your campaign by filing a Schedule 13D with the SEC. You have to do this within 10 days of hitting 5% or more of a company's voting shares.

If you're a qualified institutional or passive investor not aiming to control the company, you can file a simpler Schedule 13G instead. But with 13D, you disclose your reasons for the stake and any plans like mergers, asset sales, dividends, or policy changes.

That initial 13D filing is your chance to broadcast your case for change publicly. It also limits your ability to quietly adjust your stake or plans—any changes need a prompt amended filing.

You can use those amendments to critique the company's response. For instance, when Carl Icahn's funds took nearly 10% of Netflix and the company adopted a poison pill, they filed an amendment calling it poor governance. You might also send pointed letters, issue press releases, or lobby other investors privately.

Important Note on Tactics

Whatever tactics you use as an activist, they have to convince others. Without a hostile takeover, the only way to beat resistant management is to get enough shareholders to replace the board in a proxy fight—or at least threaten it credibly.

The Future of Shareholder Activism

Carl Icahn claimed in May 2022 that activism is dying, missing the aggressive style of the past. Some worry about 2022 SEC proposals tightening Schedule 13D rules, with Elliott Investment Management saying they'd basically end activism.

The SEC proposed cutting the filing deadline to 5 days, amendments within one day, and requiring disclosure of derivatives like options. It would also change how investor groups are defined, making coordination harder, and complicate blocking pro-ESG initiatives.

SEC Chair Gary Gensler says this fixes information imbalances. Critics argue it makes building stakes costlier and stifles shareholder talks, potentially making activism unviable.

Yet, activism isn't slowing. Take Nelson Peltz's Disney stake in November 2022, leading to a short proxy fight ended by Bob Iger's restructuring plan saving $5.5 billion and cutting 7,000 jobs—Peltz approved. ValueAct took stakes in Spotify for cost cuts and in Salesforce, where multiple activists prompted 10% layoffs. Markets reacted positively, with shares outperforming.

Do Activist Investors Ever Settle With Companies?

Yes, they do, because it's not always win-or-lose. Both sides want the company to succeed, so compromises happen. Often, activists get board seats in exchange for supporting management for a time. Agreements might outline management actions and include standstill rules on stake changes.

Is Shareholder Activism Dying?

While SEC proposals raise fears, activism hasn't slowed. It dipped in 2020-2021 due to COVID, but hit record highs in 2022, above 2019 levels. Trends suggest it'll continue into 2023 despite regulations, but we'll see.

Do Activist Investors Create Value?

They've tackled the agency problem effectively, creating value for themselves and others. But it's not black and white—they grab most gains, and their short-term focus on dividends or buybacks can hinder long-term investments.

Which Activist Investor Generates the Largest Share-Price Gains at the Outset?

It's hard to pinpoint exactly due to other factors, but from disclosures, Elliott Investment Management claims an average 8% stock rise on announcement day, adding over $30 billion in market value across targets.

Who Are the Biggest Activist Investors?

Based on assets under management as of Q1 2023, the top firms include Third Point Partners leading with $18.1 billion, followed by Pershing Square at $16.8 billion, ValueAct at $13.2 billion, and others like Eminence, Pentwater, Starboard, Trian, Effissimo, Sachem Head, and Scopia.

The Bottom Line

As an activist investor, you use your minority stake to demand changes, often pushing your shareholder rights hard to get management's attention and win over others. You might call for deep cuts, layoffs, streamlined ops, or selling off units. This discipline encourages shareholder-friendly policies elsewhere too. But you're not always correct, and any broader benefits are secondary to your profit goals.