Proxy fights, public spats, personal barbs, expensive legal fights, shorting – Activist investing ain't for the faint of heart. Also you can forget about being diversified; Activist investing is all about being highly concentrated. Paul Hilal, partner with Pershing Square Capital Management speaking recently at the Activist Investing in Canada Conference said the company "only puts three or four of their eggs in one basket, and takes a small number of swings."
Larry Sarbit, chief investment officer with Sarbit Advisory Services Inc. in Winnipeg is a big believer in the activist investment philosophy. For the past year and a half or so, he's been busy scrutinizing their moves and sizing-up their investments. That's because the veteran Canadian value manager is on the hunt for attractive activist investments for The IA Clarington Sarbit Activist Opportunities mutual fund, which he manages. The objective of this fund, which was launched in March of 2013, and is a one of a kind in Canada, is to capture the equity market upside of turnaround stories, where an activist has taken charge, i.e. to shadow the likes of a Bill Ackman or a Carl Icahn. Almost all of the stocks in the fund are American companies.
Mr. Sarbit has a broad definition of the term "activist." It can be an "external agitator" like Bill Ackman's Pershing Square hedge fund company, but it doesn't have to be. An activist could simply be an "agent of change" within a company, such as a mouthy board member, or a supercharged CEO.
With the IA Clarington Sarbit Activist Opportunities fund, Mr. Sarbit is still searching for value, but he's letting the activist do much of the legwork. By simply shadowing the activists, Mr. Sarbit is spared much of the exhaustive work of seeking out turnaround stories. And since he doesn't have to pay, for example, a mergers and acquisitions lawyer a thousand dollars an hour to advise on how to stage a proxy fight, it's a strategy that is thrifty too. "It costs us nothing," says Mr. Sarbit.
In a perfect world, Mr. Sarbit's fund captures much of the upside that a successful activist brings to a company, but doesn't have to deal with the need for enormous amounts of cash to buy up shares – or the migraines. Of course we don't live in perfect world, so how does Mr. Sarbit know for example that an activist's investment will be a hit, and not an epic fail?
First, he's picky. At any given time, Mr. Sarbit has many activist situations to choose from, but the fund only holds 15-20 stocks. So like activists themselves, Mr. Sarbit thinks long and hard before making a move.
Secondly, Mr. Sarbit does his own due diligence on every company he's considering investing in. The investment has to pass his own smell test.
"The activist investor could be absolutely wrong. Their assumptions could be faulty" says Mr. Sarbit. Quoting Warren Buffett, Mr. Sarbit says "A company can appear cheap in financial statements. But what if you end up buying an awful business?"
Another way Mr. Sarbit attempts to mitigate risk is simply to wait. He takes positions in companies not when the activist initially gets involved, but rather, after the activist's vision for the company is put in place, such as after a formal announcement on a restructuring. "We want to focus on high probability situations and outcomes" says Mr. Sarbit. That waiting period could last for years. "Patience is key."
Mr. Sarbit acknowledges that, on occasion, the watch-and-wait strategy means investors miss out on that initial pop a stock sometimes gets when an activist gets involved in a company. But by waiting, you remove the risk of suffering a nasty drop in the stock price of a company, in the event that an activist abandons an unsuccessful campaign. He also cites a paper entitled "The long-term effects of hedge fund activism," that most of the total return in a company that has been successfully targeted by an activist comes in the the five years after the turnaround is put in place. The study, published in 2013 by academics from Columbia Business School, Harvard Law School and Duke University, among others, looked at two thousand interventions by activist hedge funds between 1994 and 2007.
There are a number of things investors should consider before buying units in this fund. It only has $49.5-million under management. "This fund is tiny even by Canadian standards," says Dan Hallett, principal with HighView Financial Group. Also, keep an eye on fees. Its management expense ratio is a hefty 2.4 per cent. There is also the uncomfortable matter of its performance. When I asked Mr. Sarbit how returns on the fund have been so far, he covered his face with his hands (in an endearing kind of way, mind you), and said, "Bad!"
Since inception, the IA Clarington Sarbit Activist Opportunities fund has returned a miserly 4.5 per cent, according to Bloomberg. That's below the long-term average return of an index fund tracking the S&P 500 (and well below the index's roughly 35 per cent return since Mr. Sarbit's fund launched in 2013). Mr. Hallett acknowledged, however, that 19 months is a short period of time, and "not enough to judge this fund's strategy and execution." Mr. Hallett points out that the Sarbit fund's losses have been particularly pronounced since the broader equity markets started tanking in September. From Sept. 8 through Oct. 14 the fund fell 12.3 per cent, a much sharper drop than broader U.S. equity markets.
Mr. Sarbit says that investors in his fund, "need a long time horizon." Mr. Sarbit is clearly a patient guy. Will his unit holders be as patient?