The trillion-dollar pig

They now control $1 tn in assets in the US alone, and they have more than doubled in size in the past two years. Moreover, these funds have begun to take on a new role as activist shareholders. 

Not content just to use their financial muscle, some of these alternative investment vehicles have driven their way onto the agenda of shareholder meetings. They ask uncomfortable questions, such as: why does Company A pay a dividend instead of buying back stock? Why hasn’t Company B’s management been fired? Or even more fundamental questions like: who does the board represent? And why are we in business? 

Take a prominent recent case from across the Atlantic. Deutsche Börse, the German stock exchange group, announced plans to acquire its venerable rival, the London Stock Exchange (LSE). It wasn’t a hostile bid, nor was Deutsche Börse alone in showing interest. 

But an aggressive hedge fund with the cuddly name Children’s Investment Fund had built up a stake in Deutsche Börse of more than 5 percent. It was one of the largest shareholders in what had once been a friendly club of bankers and brokers. And it was quickly joined by another hedge fund with a sizable stake, New York-based Atticus Capital, in demanding the Germans use their cash to buy back Deutsche Börse’s own stock. They demanded a shareholder meeting to debate the plan. Management resisted. 

Even though hedge funds manage $1 tn in assets, they’re still only one eighth the size of the mutual fund industry. But look at it the other way round. From nothing and in just a few years, these funds now control something approaching 10 percent of the assets in corporate America. They want performance, and most demand quite short-term performance. Some even want poor performance, or at least a public shock to reputation that will give the funds a chance to close out a short position at a profit. 

So whose interests should the board of directors represent? One solution – the one underlying the SEC’s disputed shareholder access plan – is that large, long-term shareholders are the right voice. But that approach raises three issues:
 
1.) It gives extra power to those who make the large stakes of hedge funds possible. That $1 tn didn’t all come from wealthy individuals. Isn’t a lot of institutional money represented, from conventional portfolio managers looking to boost their own performance? 

2.) It empowers those who make aggressive short selling possible. Isn’t it conventional portfolio managers who lend the stock to the hedge funds in the first place? 

3.) It makes some shareholders, like the pigs in George Orwell’s Animal farm, more equal than others. Why is their opinion – their equity – worth more than that of retail investors or hedge funds? 

In the heightened cacophony of the shareholder base, whose voice matters? Directors should try to maximize value, and not just this quarter. They’re not on the board to increase the value of a fund that holds an open short position greater than all the equity. 

Consider this: if in doubt, listen to the customers’ voice. Satisfied  customers are in it for the long term. They can be as pig-headed as the worst investors, but they always point in the right direction. And there is no future bottom line without a future top line.