The Underappreciated Activist Investor

43,000 votes. 0.06 percent. According to IVS Associates, that’s the margin by which Nelson Peltz, head of activist hedge fund Trian Partners, won a seat on Procter & Gamble’s Board of Directors. According to the New York Times, Peltz and Procter & Gamble spent a combined $60 million on this election. This massive price tag has led investment professionals to question how activist investors like Nelson Peltz, investors who use equity stakes in public companies to put pressure on management teams, impact the global economy. Although they are often berated for wasting corporate resources and promoting short-termism, activist investors play an important role in the global marketplace, because they promote transparency, create shareholder value, and fight for social change.

To identify investment opportunities, activist hedge funds must conduct significant research. In addition to evaluating the headwinds and tailwinds affecting particular industries, these hedge funds invest significant time understanding specific businesses. That research relies heavily upon publicly available financial information, including but not limited to financial statements, note disclosures, and periodic press releases. Peter Hancock, the CEO of insurance company American International Group (AIG), argues the presence of activist investors incentivizes corporations of all sizes to be more transparent. Mr. Hancock believes companies across the globe must publish clear and comprehensive financial information to allow investors with significant technical expertise to evaluate the financial health of potential investments. Although most retail investors lack the ability and desire to identify firms who fail to meet mandatory disclosure requirements, his argument implies professional investors can and will identify companies that are not being transparent with their shareholders.

Activist hedge funds often leverage the information they acquire to create significant shareholder value. The modern public corporation has an inherent principal-agent problem. Corporate managers are not always incentivized to make decisions that will increase a company’s stock price. Instead, self-interested managers often pursue policies that ensure long-term job security, justify past decisions, preserve the status quo, and maximize personal compensation. Lucian Bebchuk, a professor at Harvard University, argues that activist interventions are able to target underperforming companies and improve long-run company performance. In other words, activist hedge funds leverage their expertise and financial resources to redirect managers to the ultimate goal of maximizing shareholder value.

These activist hedge funds generate significant value for investors. According to The Street, “activist-led funds tend to be among the best-performing in the hedge fund community.” Between 2005 and 2015, the fund Nelson Peltz managed at Trian Partners generated returns of 137 percent whereas the S&P 500 only yielded returns of 103 percent. Clearly, the institutional and retail investors who have invested in firms targeted by activist hedge funds can reap significant benefits from shareholder activism.

In addition to generating shareholder value, activist hedge funds also have the capacity to make significant social impact. Clifton Robbins, head of activist hedge fund Blue Harbour Group, pushed semiconductor maker Xilinx Inc. to monitor how much water was being used in the production process. According to the Wall Street Journal, BlackRock is requiring firms it invests in to increase disclosure of how typical business operations affect the environment. In 2013, in response to pressure from activist investors, McDonald’s published a report to shareholders that identified the firm’s process for “analyzing potential and actual human rights risks of McDonald's’ operations.” Although special interest proposals constitute a minority of total shareholder proposals, the examples listed above illustrate that activist investors can and do leverage their influence to advance important social causes.

Activist investors are not saints, nor is their work free of negative consequences. Sometimes, their proposals cause thousands of people to lose their jobs. For example, the chemical company DuPont cut 10% of its workforce, roughly 5,000 employees, in response to Trian Partners’ demands to cut costs and increase competitiveness. In a tactic known as “greenmail,” some activist investors threaten to conduct a disruptive activist campaign unless the firm in question repurchases their shares at a premium. However, to ignore the positive function activist investors serve in the global economy, namely their promotion of transparency, creation of shareholder value, and advocacy for major social issues, would be extremely unfair.