SINGAPORE: Permal’s Mark Shaw believes that highoctane activist hedge funds will continue to turn in outsized gains over the next 18 months. Find out which ‘world-class’ managers he is betting on.

A few months back, Mark Shaw, an ardent supporter of Manchester United Football Club, could not bear watching the “dreadful football” being played by his beloved team under thenmanager David Moyes.

“Every year for the last 20 years, I have gone to watch Man United play.

They were pretty bad last season,” says Shaw.

Bitterly disappointed with the club’s performance in the English Premier League 2013/14 — it eventually finished seventh on the table, its lowest placing since 1990, and failed to qualify for the lucrative European Champions League, the first time since 1989 — Shaw, along with throngs of irate Man U fans, demanded a new manager towards the end of the season.

On April 22, they got what they wanted when the club fired Moyes, who had been on the job for only 10 months, and hired Dutch manager Louis van Gaal as his replacement.

It was a classic case of fans’ activism driving change, quips Shaw, who adds that often, a change in management and key personnel — advocated by proactive stakeholders — does result in positive outcomes for organisations, be it football clubs or listed companies.

“I am delighted we got a new manager and signed up some good players.

They now look like the old Manchester United team playing exciting, attacking football with pace,” beamed the London-based portfolio manager at fund of hedge funds provider Permal in a recent interview with Personal Wealth.

Corporate activism on the rise
Like vociferous fans who boycott merchandise and refuse to purchase season tickets in a bid to pressure their football clubs to bring about positive change, many corporate activists have, in recent years, been using their position as major shareholders to influence the boards of companies they have invested in to implement changes that would positively impact their stock prices.

Hedge fund managers who use corporate activism as an investment approach typically target underperforming or undervalued companies by becoming major shareholders.

They do this by acquiring shares amounting to more than a 5% stake in the company.

As major shareholders, these activist hedge fund managers would then influence the board to stop doing business in a way that destroys shareholder value, demand changes to corporate policies, or undertake initiatives such as share buybacks, spinoffs or merger and acquisition (M&A) activities to unlock the value of the company.

These activists could have cordial behind-the-scenes discussions with the board, or exert public pressure through open letters or media coverage highlighting the shortcomings of the company.

Some powerful corporate activists, such as William “Bill” Ackman, who runs hedge fund company Pershing Square Capital, with more than US$15 billion ($19 billion) in assets under management (AUM), even use their influence to oust CEOs and initiate board restructuring.

For instance, in early 2012, Ackman started to publicly argue for a board restructuring and a CEO change in Canadian Pacific Railway, which operates railway systems throughout North America.

In a proxy fight victory in mid-2012, all seven of Pershing Square’s nominees were elected to Canadian Pacific’s board, which later appointed Hunter Harrison as CEO and hired Keith Creel as chief operating officer.

Under the new leadership, Canadian Pacific saw operational improvement and higher earnings growth, which drove the company’s share price up from less than US$60 in late 2011 to its current price of more than US$200.

Pershing Square began selling out of the railway company in mid-2013, when the share price was around US$130.

The hedge fund manager bought into Canadian Pacific at an average price of U$56.

“We are big supporters of Bill Ackman at Pershing Square.

He is not without controversy in the press.

But I think he will be one of the greatest activist managers over the long term,” says Shaw, who is part of a team that manages the Permal Activist Fund, which currently invests with 11 activist hedge funds, including Pershing Square.

“Activism has evolved and is now an established part of the investment landscape.

These are investors who take a long-term approach and seek to maximise a company’s potential.

With a market environment that remains conducive to this style of investing, and no company out of reach, we believe these investors are set to continue delivering significant shareholder value going forward,” says the 38-yearold Permal portfolio manager.

Activist funds were among the best performing groups of hedge funds last year, after turning in red hot gains of 19.22%, according to the Hedge Fund Research Activist Index.

The broader HFR Global Hedge Fund Index, a barometer of average hedge fund performance around the world, returned 6.72% in 2013.

This year, the outperformance of activist hedge funds has continued, with the HFR Activist Index generating year-to-date gains of 4.89% as at Sept 29, while the HFR Global Hedge Fund Index delivered returns of just 1.97% this year.

“Today is really a good time for the activist strategy.

The performance numbers have been good and that has attracted a lot of inflows into the strategy,” Shaw says.

Financial markets remain very conducive and corporate changes — be it M&As, buybacks or spinoffs — have led to higher share prices of companies that undertake these corporate initiatives, adds Shaw.

“Furthermore, corporate governance scrutiny is increasing and activists at large have gained incredible credibility over the past 18 months with their actions.”

Activist fund of hedge funds
Seeing increased interest from global hedge fund investors in the activist strategy, Permal, which manages around US$20 billion in AUM, launched the Permal Activist Fund in Sept 30, 2013.

Although the AUM of this year-old fund of hedge funds is barely over US$90 million, Shaw is confident that money from investors will flow in when it builds a longer track record.

This alternative investment fund with a minimum investment amount of US$250,000 is only sold to accredited investors in Singapore who have a net worth of at least $2 million, or an annual net income of $300,000.

“We started about a year ago and you are not going to get a lot of money quickly.

People we talked to in our meetings understand the strategy and the concept but they want to see [the fund] in action first and its strategy proven before putting money in it,” says Shaw.

“Interest is building and I expect to see significant inflows soon.”

To ensure that performance is not weighed down by a big fund size, the portfolio manager says the Permal Activist Fund is likely to have a size limit of around “a few hundred million”.

“The size of the fund isn’t going to be billions for sure.”

As at end-August, the Permal Activist Fund was up 5.28% on a year-to-date basis.

“Performance has been good and we are pleased [with] how we filled out the portfolio.

Activism as a strategy has generated a lot of headlines of late due to a number of high-profile managers.

We have allocated to some of those managers because we think they are world-class.

But we are also able to source some smaller [lesser-known] managers of high quality.

Everybody has heard of Pershing Square and Trian Partners [run by activist investor Nelson Peltz), but not everyone has heard of Stonerise Capital Partners, P Voce Ltd or Sachem Head Offshore.

So we have a good mix,” explains Shaw.

Activist players
The Permal Activist Fund currently has money invested with 11 activist hedge fund managers, including Ackman of Pershing Square, Peltz of Trian Partners, Barry Rosenstein of Jana Nirvana Offshore Fund, Mick McGuire of Marcato International, Keith Meister of Corvex Offshore, Petteri Soininen of RWC European Focus Fund, Jeff Cozad of Stonerise Capital Partners, J Daniel Plants of P Voce Ltd, Scott Ferguson of Sachem Head Offshore, Christopher Hohn of The Children’s Investment Fund and Christer Gardell of Cevian Capital II.

“We are committed to a maximum of 12 underlying managers.

We do not want this to be a fund with 20 to 25 underlying managers.

This is a high conviction fund investing in managers we really like,” says Shaw, who only invests with managers who are pure activists.

“First, they have to be outstanding managers.

If their funds are closed [for subscriptions], we can still have a discussion with them as not everyone is ‘hard-closed’.

There are a few funds in our portfolio that are closed today, but we either have capital with them or a very good relationship.

I couldn’t think of anyone we couldn’t give money to,” he insists.

Shaw says many of his company’s rivals today could not build a similar portfolio as the Permal Activist Fund because some of the hedge funds in its portfolio are hard-closed for subscriptions.

Other well-known hedge fund managers who are not pure activists but run diversified strategies, including activism, in their funds are not considered for the Permal Activist Fund, Shaw says.

That is why his fund has no money invested with Dan Loeb of Third Point LLC or Paul Singer of Elliot Management Corp.

“Some fund managers run multi-strategy funds which [involve] activism.

As a firm, we have capital with Third Point and we think very highly of Dan Loeb, but he is not a pure activist.

It is just a part of what he does.

He also does corporate credits, global macro, long-short equities and other strategies.

Activism isn’t the primary driver of his returns.

Similarly, Paul Singer of Elliot, whom we think very highly of, isn’t a pure activist play.”

Manager selection
Besides the quantitative screening of hedge fund managers based on their track record, risk management capability and investment holdings, Shaw makes sure that he speaks to each of the underlying managers of his portfolio to gauge their “qualitative aspects”.

“During such meetings, there is no checklist.

I am paid to assess the managers based on my value-add as an experienced portfolio manager.

I have done this for 8½ years and have researched in excess of a thousand hedge funds.

It [comes down to] my ability to assess the intangibles that make a manager great,” he says.

Nonetheless, all his invested hedge fund managers need to have invested their own money in their own funds.

They also have to be supported by a high-quality and experienced investment team.

“We don’t invest in a ‘one-man shop’.

We also want to see examples of their credibility and success as activists.”

There are about 200 activist hedge funds worldwide, and a steady stream of new players coming into the activist strategy, which has attracted a lot of attention and money from investors over the past 18 months, says Shaw.

Around 40 to 50 of these are credible managers in activism, he observes.

“Some are good, some are [the] fly-by-night type, which you want to avoid at all costs,” he tells Personal Wealth, adding that his team is constantly sourcing for new activist managers.

Among the activist hedge fund managers he has meet, Shaw is most impressed with Ackman and McGuire.

In the 10 years since Pershing Square started its operations, Ackman has delivered annualised returns of 20% net of fees, he notes.

“That is an extraordinary record.

His style of investing hasn’t altered and he has always been focused on large caps.

Over the years, his credibility and reputation have increased significantly.

He is one of the smartest managers I have known and one of the most creative, determined and focused.

His whole aim is to generate one of the greatest track records in the hedge fund industry.

He doesn’t care about all the paraphernalia and the money, and everything that goes with success; Ackman just wants to create one of the greatest records,” says Shaw.

Earlier this year, Pershing Square teamed up with Canada’s Valeant Pharmaceuticals in a hostile effort to take over Botox maker Allergan, which has rejected their offer, stating that it undervalues the California-headquartered healthcare company.

Pershing Square, which is Allergan’s largest shareholder with a 9.7% stake, has since been pushing for a special meeting with the US healthcare company’s shareholders, in an attempt to replace the current board of directors with the hedge fund’s nomi nees, in order to push the deal through.

Since Valeant announced its take over plans in late April, Allergan’s stock price has surged more than 30%, adding around US$1 billion in paper gains for Ackman, whose Pershing Square has turned in gains of more than 30% this year.

Market observers reckon that as a major Allergan shareholder, Pershing Square will benefit regardless of whether or not the takeover goes through.

Either way, Ackman will win.

“This speaks of his credibility and creativity,” says Shaw.

After rebuffing Valeant’s take over attempt, Allergan announced cost-cutting measures to improve its efficiency and is currently trying to persuade shareholders that it is better off as a standalone entity.

Mick McGuire of Marcato is another activist hedge fund manager whom Shaw places high hopes on.

McGuire was a partner and the third-most-senior employee of Pershing Square before he left the New York-based hedge fund in 2009 to start his own firm, that started investing in October 2010.

“We knew McGuire when he was working alongside Ackman.

He was a very smart analyst at Pershing Square.

We were a very early investor with him.

I think McGuire is a very talented manager.

He has proven from day one that he has the ability to engage with companies.

He is thoughtful and knows whom to work with to effect changes.

McGuire prefers to be behind the scenes, but when it is necessary, he will bang the tables,” says Shaw.

Last year, McGuire targeted auction house Sotheby’s, in which he initiated a position in May 2013.

By end-July 2013, Marcato owned a 6.6% stake in the auction house.

With McGuire working behind the scenes, Sotheby’s announced in September 2013 that it was reviewing its capital allocation and financial policies.

That month, it also appointed a new CFO, Patrick McClymont, a former Goldman Sachs partner and managing director.

In October, Third Point’s Loeb entered the fray by sending a scathing letter to Sotheby’s management calling for the removal of chairman, president and CEO William Ruprecht, who, he claimed, was getting a “generous pay package”.

The hedge fund manager also said that Ruprecht’s interest in the company is not aligned with that of shareholders.” Shares in Sotheby’s surged from US$33 in May 2013 to close at US$48.6 at end-2014.

McGuire has since shifted his targets to hotel chain Intercontinental Hotels and Life Time Fitness, which operates fitness centres in the US and Canada.

Although Marcato International’s performance has not been up to expectations this year, Shaw continues to have faith in McGuire’s ability to turn in decent returns over the longer term.

“Mick has had a tough year.

But he invests in names for a multi-year period and his strategy remains intact,” says Shaw, who spoke to McGuire on Sept 15.

“We discussed his biggest positions.

His portfolio is loaded with some very interesting ideas and I don’t see why it won’t work,” adds Shaw, who seems willing to stick with McGuire for another year or so.

He tells Personal Wealth that he is not afraid to replace underperforming managers when they fail to live up to expectations over an 18-month period.

When a hedge fund in his portfolio underperforms, Shaw and his team will “scrutinise it more deeply”.

“We have to know why the manager is not performing.

Did something alter his strategy or did we miss something that was going on? Maybe his team just wasn’t good enough, or he had too many other activities on the go.

You’ve got to assess each case on its own merits.” Shaw says he will be patient with underperforming managers if their investment strategies remain intact, but patience has a limit — of a year to 18 months.

“We have a pipeline of some really good managers.

If you are not performing, there are a lot of other people who will.”

Diversification
Besides investing in different hedge fund names, the Permal Activist Fund is also diversified in terms of geography and market cap.

Some of its managers, such as Ackman, invest in US large-cap stocks, while others such as Plants and Ferguson target small- and mid-cap counters.

Shaw says the US equity market is the most amenable to corporate activism.

In his view, US companies have better corporate governance, greater transparency and a higher acceptance of activist investors.

“That’s why we got more assets in the US, but we are seeing more activism outside the US and we want to build on that.

Today, we have The Children’s Investment Fund that does global investing, including in Japan, and RWC European Focus and Cevian Capital focusing on the European markets.”

As a portfolio manager, Shaw says his job is to ensure that his activist fund of hedge funds has underlying managers who are “not doing the same thing”.

He points out that in the top five holdings of Permal Activist Fund’s 11 underlying managers, not a single stock name overlaps.

“That speaks of the breadth of opportunity currently in the activist space, as well as our ability to construct a portfolio,” says Shaw.

“There are so many deals going on today, it is extraordinary.

Each of these managers is actively engaged with three or four companies.

There is so much happening and I think it is really exciting times.”

Conducive environment
In general, the current market environment remains “fertile” for corporate activism at large, says Shaw.

“I don’t think that is about to change in a year or two.

We know US interest rates are going to go up at some point.

As a corporate, you want to alter your capital structure to take advantage of the favourable rates, and you probably want to do some deals today.

That is what we are seeing,” observes Shaw, who sees activities such as M&As, spinoffs and share buybacks continuing into 2015.

“Even if rates were to go up from the current rock-bottom levels, money is still effectively free to many companies.

I don’t think it is going to change a great deal of deal appetite [when US interest rates start to move higher].

We are going to see corporate activities continuing.”

Activism as an investment strategy certainly looks attractive.

But having exposure to some of the world’s best activist hedge fund managers through the Permal Activist Fund does not come cheap.

Indeed, investors of this fund of activist hedge funds are charged an annual management fee of 1.5% and a performance fee of 5%.

They are also subject to an early withdrawal fee of 5% if they sell out within the first 12 months.

These fees are reasonable, Shaw reasons.

“First, we monitor the activist hedge funds regularly.

We actively engage in dialogue with each and every one of them.

Second, we are constantly sourcing for newer and better managers.

That is the kind of value-add we give investors.

“You get what you pay for,” he says, citing Manchester United’s recent record signing of Argentine midfielder and formal Real Madrid star player Angel Di Maria, for £59.7 million ($123.4 million).

To date, the new acquisition has scored two goals and assisted in another two in the English Premier League.

“Di Maria cost a fortune but he is one of the world’s greatest players,” the Man U fan adds.

This article appeared in the Personal Wealth of Issue 646 (Oct 6) of The Edge Singapore.