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Study: Institutional Trash is Hedge Fund Treasure

A new study of trading data related to major 'activist' hedge fund acquisitions indicates that institutional investors are usually on the other side of the deal.

(September 4, 2012) – Hedge funds are buying what institutional investors are selling, according to new research into major public equity trades.

A recent whitepaper asserts that when a hedge fund picks up more than 5% ownership in a certain stock, it’s usually because a pension or mutual fund has unloaded its holdings. Nickolay Gantchev and Pab Jotikasthira, both finance professors at the University of North Carolina in Chapel Hill, analyzed scores of trading data from major hedge fund acquisitions and high frequency trades by non-hedge fund institutions. 

‘Activist’ campaigns by hedge funds—targeting and quickly buying significant ownership in certain companies, with the intention of influencing operations—have been steadily on the rise. In the last decade, hedge funds have launched more than 300 such attacks on major companies, according to research out of Harvard. And the majority of the time, institutional investors facilitate these purchases, Gantchev and Jotikasthira found. 

“At the daily frequency, we find a strong positive relationship between the net selling of pension and mutual funds and the hedge fund’s purchase of target shares,” the authors write. “Examining their trading in other (non-activist) stocks, we find that a significantly larger fraction of these [institutional] funds’ trading constitutes selling suggesting that they are relatively more ‘distressed’ and trade for liquidity reasons…We find that institutional selling lowers prices and increases turnover, creating a favorable market environment for the activist to acquire a large quantity of target shares.” 

If pension funds and mutual funds are usually the sellers of these powerful pools of shares, they’re also often the buyers, albeit indirectly. Institutional investment in activist hedge funds has jumped in the last two years, as asset owners seek out robust, uncorrelated equity returns. In January, for instance, New Jersey’s public pension system sunk $150 million into Cevian Capital II. In a letter proposing the allocation, Director Timothy Walsh described Cevian’s investment style as “hands-on and constructive.” The hedge fund “conducts intensive research and creates action plan to enhance the value of the company before making investment or engaging in a dialogue with the management. [Cevian] improves governance, operations and frequently joins the board of directors to affect change,” Walsh wrote. The fund has returned an annualized 11.46% since its inception in 2006. 

Likewise, two major activist funds, ValueAct Capital Management LP and Starboard Value LP, recently announced they have sealed off investment in their activist strategies, capped at $8 billion and $1 billion, respectively.

Read all of Gantchev and Jotikasthira's paper here.

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