Monday, April 11, 2011

World Economic Forum on "The Future of Long-term Investing"

In light of the financial crisis, there has been an increased concern that short-term objectives are outweighing long-term growth and value creation. Long-term investors play a key role in providing direction for corporations and in stabilizing the economy during times of distress. While short-term investing provides liquidity and "accountability on the part of corporate managers…, the market does not seem to be lacking in short-term capital". The World Economic Forum recently released a report, "The Future of Long-Term Investing", which addresses key investment concerns going forward from the financial crisis.

"Long-term investing can be usefully defined as investing with the expectation of holding an asset for an indefinite period of time by an investor with the capability to do so."

The report highlights "life insurers, pension funds, sovereign wealth funds, foundations and family offices" as possible sources of long-term capital. Although these institutional investors manage $27 trillion of the $65 trillion professionally managed assets, there are several constraints (highlighted in the report) that allow only 25% of their assets to be allocated as long-term capital. Moreover, the report expects a "decline in long-term investing by life insurers and pension funds", which have traditionally been the largest long-term investors and have a total of $22 trillion AUM (approximately a third of all professionally managed assets). While family offices, sovereign wealth funds, endowments, and foundations will likely increase their assets…,

"[W]e expect that there will be an overall reduction in the proportion of global investable assets directed towards long-term investing, with potentially significant economic implications."


While the length of time necessary for an investment to be considered "long-term" varies, the report states it is "typically… for at least 10 years or through an entire business cycle". Consequentially, assets ideal for long-term investment are usually riskier and more illiquid. The following classes meet such criteria: direct venture capital, infrastructure, direct private equity, and strategic positions in public equity--the last of which is defined to be, "[m]ajor stakes in public companies often associated with a board position and potential lockup period".

Several constraints hinder long-term investing: liability profile, investment beliefs, risk appetite, and decision-making structure. Moreover, certain constraints impact long-term investors differently. While the constraints for family offices (which have $1.2 trillion AUM) are minimal, the constraints for both pension funds and life insurers (which have $22 trillion AUM combined) are significant--and increasingly so. Consequentially, family offices are able to allocate nearly the same amount of capital toward illiquid investments (~$420 billion) as life insurers, despite having only slightly more than a tenth of the AUM life insurers have. All told, constraints result in total actual illiquid investment by long-term investors being less than one quarter of its potential ($6.5 trillion of $27 trillion potential).


The report lists the three primary benefits of long-term investing,

(1) might offer better returns to certain investors;
(2) could bring benefits to individual corporations; and
(3) may be a 'social good' by helping to stabilize the financial markets, promote global economic growth and bring wider social benefits. (Read the report, The Future of Long-term Investing, for more details)

Long-term investors benefit by being able to access structural risk premia, take advantage of secular themes/ macro trends, impact corporate decision-making, avoid buying high and selling low, and minimize transaction and market disturbance costs.

The report states that while academic literature is unclear on the size and length of abnormal announcement returns due to long-term investor presence, "there is strong evidence presented… that sovereign wealth funds induce positive abnormal returns for target investments, at least for a short [period of time]". (Note - Research papers concerning shareholder activists have generally shown positive abnormal short-term and long-term returns (read more)).

Moreover, many believe that the financial crisis has indicated that the short-term liabilities of a corporation could compromise its long-term investment portfolio and focus. Equally troubling is the fact that some managers have focused on the short-term as a result of principle-agent problems, unfavorable valuations from takeovers due to temporarily depressed earnings and imperfectly informed stockholders (Stein, 1988), and rational market adjustments to earnings inflation (Stein, 1989), to list a few. Hence the importance of shareholder activism,

"If short-termism can be shown to exist, it offers a powerful argument for the offsetting benefits of activist investors with a long-term horizon… [S]hareholders would become aware of the negative effects of [short-termism] and act to prevent them."


During the financial crisis, many long-term investors failed to properly cover their positions and to "reallocate capital to equity when the value of equity holdings dropped". The financial crisis also saw unanticipated highly correlated declines between different asset classes. This experience raised questions concerning ideal portfolio diversification.

"For many investors..., the crisis and the current economic climate have raised tough strategic questions and highlighted the need for rebuilding investment frameworks and governance processes."

Among some of the governance process and investment framework changes we can expect from long-term investors: explicit clarity of investment beliefs and their implications; debate within organizations about risk exposure, especially considering liquidity and regulatory constraints; frequent dialogue with stakeholders; greater accountability balancing short-term considerations with longer-term ones; and the development of compensation schemes beter aligned with the long-term.

In addition, the report states, "There are also signs that long-term investors have become more interested in select hedge funds" for improved alpha, as well as risk and volatility reduction.


For both long-term investors and policy-makers, the World Economic Forum lists six recommendations "to ease the constraints on long-term investing and increase the benefits that flow from it".

In regards to shareholder activism, the report makes clear,

"It is... important to stress that shareholders can and should hold management accountable for their actions and direct them to manage their business towards the creation of long-term value"

The report also goes on to implicitly note the constraints to shareholder activism, "Although this [above statement] sounds like an uncontroversial recommendation, many corporations do not necessarily welcome the active involvement of shareholders". The World Economic Forum encourages "responsible ownership that plays a measured and active role while not exerting undue influence to promote the investor's aim at the cost of the corporations and other shareholders". Accordingly, the report concludes by proposing that long-term investors:

- "make the exercise of ownership rights part of the mandate of an investment manager";
- "investment managers could work with their investee companies to help develop long-term goals and identify long-term risks";
- "long-term investors could work with each other to promote long-term decisions on the part of the corporations in which they invest".

Read The Future of Long-term Investing

Posted by David Schatz

Monday, April 4, 2011

Activist Investors Talk Strategy

Phil Goldstein, Bulldog Investors
While there has been much press coverage about activist 13D filings of late, CNBC's The Strategy Session has been particularly effective in shedding light on the activist modus operandi. On March 18, 2011, Phillip Goldstein discussed the benefits of SPAC investing. He views SPACs as "extremely safe… If [management] can't come through with an attractive transaction then you get your money back… But you have the optionality--if they do come through with an attractive transaction--that the the stock can go significantly higher… You can't lose".

Note: On January 22, 2009 Damien Park, Managing Partner Hedge Fund Solutions, wrote an article for RealMoney titled, "Activists Pounce on SPACs".  One year later we posted the investment returns of the SPACs listed in the article.  [Available Here]

Goldstein also spoke about hedging volatility risk through investing in special situations and how the environment for activism is "excellent". Currently, Goldstein believes he has found "a very attractive situation" at Casey's General Stores (NASDAQ: CASY), which earlier escaped a $2 billion hostile offer from Couche-Tard, then rejected a $43 per share friendly takeover offer from 7-Eleven, and has recently missed earnings expectations. Goldstein acknowledges that while the company is well managed, it is now trading at a discount to the valuations of previous offers and is thus an ideal candidate for both shareholder activism and a takeover. CASY is unique to Bulldog's portfolio, as the activist typically invests in closed-end funds trading below NAV and then persuades management to make a transaction that closes the discount. According to Goldstein, "It produces alpha--real sustainable alpha without leverage--and reduces risk over the long-term. It works".

Donald Drapkin, Casablanca Capital
Several days later, CNBC also had Donald Drapkin on The Strategy Session. Drapkin discussed shareholder activism, characteristics of hostile takeover targets, and Mentor Graphics. Interestingly, one of the companies that they highlight as a possible target, Pentair (NYSE: PNR), has also been pressured for a breakup as a result of recent strategic shareholder activism elsewhere. In particular, the pressure has intensified due to the recent breakups of ITT, Fortune Brands, and Motorola by campaigns from activist shareholders Relational Investors, Pershing Square, and Carl Icahn, respectively. Accordingly, Drapkin states that "Pentair is on everybody's list". Marvell and Mattel--the latter of which Icahn currently has a position in--were also highlighted as possible mid-cap targets based on their lagging price-to-book ratios, low debt-to-equity, strong interest coverage & sufficient cash flow, and shareholder value at the low end of 52-week range.

Drapkin emphasized "[some] of the things that you look at as an activist investor":

- stock underperformance;
- excessive compensation;
- directors not having a sufficient equity stake in the company;
- slow business development;
- excessive SG&A; and

for hostile takeover targets:
- divisional misalignments; and
- cash holdings.

See Also: More Hostile Takeovers Likely This Year

Posted by David Schatz

Activists Hope to Mirror Success of Barington

In an earlier post, we highlighted five activist campaigns underway this proxy season. The score is now 1-0 in favor of the dissidents: Shareholders of Ameron International (AMN)--which had its annual meeting on March 30, 2011--overwhelmingly voted for the election of activist investor James Mitarotonda, CEO of Barington (preliminary votes indicate 72% of votes cast were in support of the sole dissident nominee). Read the MarketWatch story.

On March 11 Ramius withdrew their nomination to elect three individuals to Immersion Corp. (IMMR) following a March 9 announcement by the Company that they have agreed to add two new Directors from activist investor Dialectic Capital to the board.  Elsewhere, Ramius' proxy contests at Zoran Corporation (ZRAN) is about two months away from the annual meeting, and other formal proxy solicitations have begun heating up at EMS Technologies (ELMG) and Mentor Graphics (MENT). Below is a summary of the latest relevant developments.

EMS Technologies (ELMG); Annual Meeting: May 12, 2011
Annually elected 10 member board
Activist Investor: MMI Investments (7.8% beneficial ownership)

Activist Concerns:
- business is overly complex and too small for the public market
- company has not been taking advantage of thriving M&A environment
- dead hand provision to poison pill (the provision was removed on 1/4/11)
- lackluster stock performance
- current board lacks genuine corporate credentials
- wasteful $150 million worth of acquisitions

Major Developments:
- MMI and ELMG begin formal proxy solicitation and name nominees.
- ELMG amends Executive Protection Agreements and EAICP that provide golden parachute compensation for executives whose employment is involuntarily terminated (other than for disability or death) or voluntarily terminated due to certain adverse employment actions within two years after a Board-approved change-in-control. The plan provides a "lump-sum payment of the present value of two years' salary", benefits, and target awards.
- MMI nominates 4 individuals to the board.
- ELMG announces on 2/2/11 that they have retained BofA Merrill Lynch to serve as a financial advisor for exploring strategic alternatives.
- ELMG removes dead hand provision to poison pill on 1/4/11.
- MMI pushes ELMG to sell the entire company.

ELMG's depiction of its stock performance:

MMI's depiction of target's stock performance:

For a complimentary copy of Hedge Fund Solutions' in-depth research on the activist situation at ELMG contact

Ameron International Corporation (AMN); Annual Meeting: Completed for 2011.
Staggered 7 member board

Activist Investor: Barington Capital (1.3% beneficial ownership)

Activist Concerns:
- pay-for-performance disconnect and excessive executive compensation
- low insider stock ownership
- excessive anti-takeover defenses
- underperforming peers and market for the last 1-, 2-, and 3-year periods

Major Development:
- Shareholders voted overwhelming in favor of the election of activist nominee James Mitarotonda. Company nominee David Davenport is not re-elected, but CEO James Marlen is re-elected.
- Barington nominates 1 individual to board.

Mentor Graphics (MENT); Annual Meeting: May 12, 2011
Annually elected 8 member board
Activist Investor: Carl Icahn (14.7% beneficial
Activist Investor: Casablanca Capital (5.48% beneficial ownership)

Activist Concerns:
- lack of cost containment
- poor corporate governance decisions (eg. moving annual meeting of shareholders)
- operational inefficiencies

Major Developments:
- Icahn names nominees.
- Icahn calls the debt issuance "cynical", "an absurd offering", "poisonous", and "ask[s] that [MENT] immediately make public all of the terms of the deal so that shareholders can evaluate what [the company] has done". Tells the board that its "shareholders are not irrelevant and will not be fooled. There was no need to issue convertible securities and there were clear alternatives".
- MENT issues convertible notes.
- MENT rejects Icahn's takeover offer and debt financing.
- Icahn offers to lend MENT $220 million on a 6.25% senior unsecured basis.
- Icahn and Drapkin (Casablanca) reiterate that the company should seek a sale and that Cadence Design Systems is an ideal acquirer.
- Casablanca rescinds its nomination and states intent to vote in favor of Icahn's slate.
- Icahn makes hostile $17 per share offer.
- Casablanca nominates 3 individuals to Board.
- Icahn nominates 3 individuals to Board.

Drapkin: "If Carl gets his three seats on the board, I think that will start a process from which the company will have no choice but not to back away... because then they know that the next meeting is coming up and if they haven't done something dramatic then they will lose control over the board... In a free market, we have the right to go in and make our voices heard. The Chairman of the company owns virtually nothing. He pays himself a lot of money, but he owns virtually nothing. He has been there forever... The company just doesn't do anything".