View from the board: hedge fund survival

Several famous examples of hedge funds pouncing on major companies have made
headlines here, too. Take Time Warner, for example. (Carl Icahn nearly did).
They haven’t been as common in the UK, but there are still some fairly
well-known examples of ambushes by hedge funds – Wyevale and Woolworths to name
two.

Generally, hedge funds make their money in the old fashioned way. Buy shares
in an undervalued company, wait, sell. However, where hedge fund players differ
from typical investors is that they will try to explain to the market what the
company is doing wrong. Often, they will employ a number of public relations and
editorial stratagems to make the debate public, so the management has to do
something about it. This is only one of many strategies which hedge funds will
use to pile pressure on management.

In many ways, there is some value in this approach, particularly if it adds
value to the group. It’s when you look at the sort of returns these funds are
expected to make that the problems begin. While many hedge funds are good at
pricing real value, the risk is that issues have been fabricated merely to stir
up volatility and a quick return.

So if you find yourself on the receiving end of the hedge fund approach, how
can you deal with it? Sadly, there is no easy answer. Ideally, you want to
ensure that you never let the business get into a situation where the hedge
funds start circling. However, if they do, then the answer may well be to look
to the US. Companies that have seen off the threat there (like Time Warner) have
entered into the debate willingly, and explained patiently to shareholders why
the views of the funds are wrong.

They have acknowledged some of the points made – there’s no reason not to
listen to free advice from some very intelligent people. However they have also
explained to the shareholders why it may well be better to work with a
management team with a long term view, than a hedge fund who wants an instant
return, and then moves on to the next target.

More than two millennia ago, the Chinese general and strategist Sun-tzu said,
‘Keep your friends close and your enemies closer’. Let us hope that is the only
parallel between ancient Chinese warriors and survival in today’s equity
markets.

Mark Freebairn is a partner at Odgers Ray & Berndtson