Commentary

Shareholder Activism In Asia

Shareholder activists have long been a feature of corporate life in the United States. But as the field becomes more crowded at home, established US-based activist investors are looking overseas for opportunities. And their focus has been on companies in Asia.

Analysis from Activist Insight highlights the number of activist public actions in the region has steadily increased in each of the past four years. Asian companies are now more targeted by activists than their counterparts in Europe.

There is no doubt that the public profile of engagements between activists and boards in Asia is growing, be it arguments over corporate structure in South Korea, questions regarding capital in Japan, or demands for reorganisation and divestitures in Australia.

Previously, Asia has been seen as a relative backwater for shareholder activism. This is partly due to a greater propensity for listed companies to have controlling shareholders, often founders and family interests, or embedded government interests. The prevalence of cross-shareholdings among groups of affiliated listed companies is also an issue, as is greater relative passivity among institutional and retail investors, cultural resistance to US-style activism, and local environments that are generally less litigious and confrontational.

However, while culture is important, the disparity in shareholder activism between Asia and other markets is also a reflection of the maturity of the markets in question.

Editor’s Letter - Issue 123

Shareholder activism is gathering momentum and going global. It is most prevalent in the United States, where Schulte, Roth & Zabel recently scored an unprecedented litigation victory on behalf of venBio Select Advisers LLC, in the Immunomedics proxy contest. For the first time, a major corporate deal that sought to entrench incumbent management was unwound in the context of a proxy contest. In this issue we interview some members of the SRZ teams who advised venBio. Canada may even be more activist-friendly than the US in several respects, say local lawyers, Goodmans.

The tally of public activist campaigns in the US has almost quadrupled from 123 in 2010 to 476 in 2016, according to Activist Insight. In the UK the number has fluctuated between 21 and 43 without any clear uptrend over the past seven years, but both US and UK managers have secured notable successes. Paul Singer’s Elliott Advisers managed to install independent directors, and new management, at Alliance Trust. Jeffrey Ubben’s ValueAct has obtained a board seat at Rolls Royce and Martin Hughes’ Toscafund has got one of its nominees onto the board of Speedy Hire.

In Europe outside the UK, the number of public actions has multiplied six-fold from 10 in 2010 to 60 in 2016. But there has been mixed success. Elliott has, thus far, found corporate governance in the Netherlands less conducive to activism. Elliott, and other shareholders, including the UK’s largest pension fund, the Universities Superannuation Scheme (USS), were denied the chance to discuss, and vote on, the chairmanship of Akzo Nobel. USS co-Head of Responsible Investment, Daniel Summerfield, said “this portrays Dutch governance in a very negative light”. The Akzo board has thrice rejected PPG’s takeover offer.

SYZ Hedge Fund Summit 2017

I have been investing in hedge funds for more than 30 years. The first time was in the early 1980s, when I was a stockbroker on Wall Street, and friends of mine were doing a lot of business with what they called hedge funds. I didn’t know what hedge funds were so I tried to find out. The next thing I knew I was standing in George Soros’ office, and didn’t know who he was. Soros was managing a few hundred milliondollars at the time; and that’s how I got acquainted with hedge funds.

I started to invest in hedge funds, and ever since I’ve been investing in hedge funds. Of course, in those years we got 15 to 20% returns by just allocating to 10 or 12 different hedge funds but we had an interest rate environment which was very, very different. People tend to forget that in those years hedge funds were returning in the 20s and 30s but interest rates were in the double digits.

Now, in the current environment with the risk-free rate of return being where it is, it’s very hard to perform anywhere, for hedge funds as well. Having said this we’ve always been investing in hedge funds even though the times were hard, and they fell out of favour.

One of the reasons why we decided to launch this conference was that the interest rate environment is getting back to a more positive note in the United States and around the globe. I think the deflationary period is over and people are no longer scared of deflation. I was just talking with somebody who thinks that there’s a possibility Europe will see higher rates over the next few quarters, and that is a positive environment for hedge funds. It’s disruptive for the market, but this often means there are also opportunities for hedge funds. I think there’s going to be a new revival for this investment style.

Product Governance and Investor Protection

MiFID II is looming and the entire industry is still grappling with some of the additional obligations - some of them unusually burdensome and costly to implement - the recast directive will impose on market participants.

In particular, MiFID II introduced a new set of product governance rules designed to increase the level of investor protection. As stated in the ESMA Consultation Paper on Draft Guidelines on MiFID II product governance requirements, these new rules aim at ensuring that product manufacturers of financial instruments and structured deposits, as well as distributors, have at all times the best interests of the investors in mind. The new product governance requirements under MiFID II are introduced having in mind the best interests of investors. When it comes to presenting a client with an investment product or solution, according to the new rules this will have to be perfectly suitable for their best needs and interests, which should at all times prevail over commercial or funding needs of investment firms.

Whilst the importance of clients’ best interests - boldly emphasized throughout MiFID II both in the first level directive as well as secondary level delegated directive - is not necessarily new, the approach now adopted in the European legislation on financial services with regards to investor protection appears to be innovative, at least at a first glance. It was felt - as also stressed in the Draft Guidelines - that the mere existence of conduct of business rules was not always sufficient to ensure investor protection. Efficiently and effectively enhancing such protection required that the consideration of the needs of the investor was not only anticipated at the very moment when a specific investment product is manufactured, rather than simply at the time it is offered or sold, but also maintained during the life-cycle of the product.

Man FRM Early View

Barring a significant polling shock in the second round of the French election, Macron winning the French presidency would seem to usher in a new era of confidence for risk assets. We are not so sure.

Beyond the brief respite from political worries, the positive case rests on the current state of global growth: it is broader, more robust and more sustainable than at any point since 2008. Emerging Markets are a growing component of that growth, but even there the issues around balance of payments and commodity dependency seem to be less prevalent than they have been for much of the last few years.

The problem is how Central Banks react to this better landscape and the implications for the risk free rate of return. Hidden in all the excitement around the French election were robust Purchasing Managers’ Indices and earnings data across the Eurozone. A Macron victory may be the last piece of the puzzle for Draghi to begin tapering Quantitative Easing at the June European Central Bank (‘ECB’) meeting. Add to this a snap UK election, which if polls are correct will give the Conservatives a stronger majority, and we could see the Bank of England (‘BoE’) reverse the emergency moves it introduced after the Brexit vote last summer. In this view, we have a world with three of the major Developed Market Central Banks reversing the policy of the last decade.

So perhaps the change in the direction of travel from Central Banks is now upon us (in hindsight, it clearly wasn’t in December – the Federal Reserve (‘Fed’) raising rates matters little to global risk assets when other Central Banks start pumping harder in their place), which may mean more normal markets: a higher risk-free rate, Bond yields up from their record lows, and Equity markets reacting to bad news without an enormous bid waiting on the side-lines to buy the dip.

Gold Options

In the one-and-a-half months after the US elections on November 8, gold prices plunged 12% on the assumption that the incoming president’s fiscal stimulus would boost the economy and lead to higher interest rates. However, with the Trump agenda running into numerous roadblocks since then, the yellow metal has rebounded, recouping nearly all its post-election losses. Gold options, meanwhile, have perked up from their recent lows, but with implied volatility at less than 14% they remain historically inexpensive (Fig.1).

Going forward, there are possibilities of big moves to the upside and downside that could reawaken the sleepy options market and lead gold options to significantly higher levels of implied volatility. Although many factors influence gold prices, we see two elements playing a dominant role:

1. Expectations for changes in US monetary policy.
2. Changes in gold mining output.

These two factors exert their influence in very different ways. The first is demand-based and moves gold prices on a day-to-day basis. The second is a supply-based influence that appears to move gold prices on a year-to-year basis. Both factors have the potential to create strong trends in gold prices and impact the implied volatility of gold options.

Japanese Hedge Funds

Two years ago we wrote in this publication about our conviction in Japanese hedge funds, due to their track record of generating consistent alpha and managing risk during down periods in the markets. Similarly, we explained how these managers had, over the course of almost two decades, acquired a unique set of skills which had helped them to navigate through tough market conditions and deliver attractive long-term risk adjusted returns. We discussed how the size and depth of the Japanese stock markets, coupled with low research coverage compared to other developed markets, provide the right investment framework for home-grown hedge fund managers to develop an edge over foreign institutional allocators as well as local retail investors, and how these managers were able to uncover mispricing opportunities.

We also looked into how a range of idiosyncratic factors such as cultural differences and the language barrier have made it harder for foreign investors to participate in the market, and have allowed local managers to be alpha generators. Our conclusion at the time was that while the changed macro outlook for Japan had triggered increased flows from global long only allocators, investors should challenge the prevailing wisdom that the main reason for betting on Japanese equities was the turnaround of a protracted Japanese bear market, and instead focus on the alpha generation opportunities available in this unique market based on identifying investment ideas generated and executed by the most experienced local managers.

BDC Fees and Structures Evolving

A proliferation of different fee levels and structures is evident throughout the alternative investment industry, and Business Development Companies (BDCs) are no exception. For instance, management and incentive fees within the BDC space vary widely between issuers, with management fees ranging from as low as 1% to as high as 2% of gross assets. Throughout the industry, common drivers for revisiting existing fee structures include changing market norms and pressure from investors. BDCs can face additional demands to alter fees and terms in view of their public nature. Being publicly listed opens the door to pressure from both analysts and activist investors, and BDC regulation, namely section 15 under the Investment Company Act of 1940, or the “1940 Act”, requires boards of directors of BDCs to review and reapprove fee agreements annually.

Advantages of Systematic Investing

Writing in 1923 about the famous discretionary speculator Jesse Livermore, the American author Edwin Lefèvre captured in a quote the frailties of human psychology when it comes to investing in financial markets: “It is inseparable from human nature to hope and to fear. In speculation when the market goes against you - you hope that every day will be the last day - and you lose more than you should had you not listened to hope... And when the market goes your way you become fearful that the next day will take away your profit, and you get out - too soon. Fear keeps you from making as much money as you ought to.”[1]

In this paper, we review the key advantages of the systematic approach to investing. In addition to the avoidance of investment error due to psychological bias, a systematic approach offers several key benefits including: the scalability to invest with a consistent approach twenty four hours per day across a global portfolio of securities; the implementation of consistent risk management at security, asset class and portfolio level; and, the scientific rigor which can be devoted to the continuous development of the core investing approach. We also review academic evidence comparing the performance of systematic and discretionary CTAs and hedge funds.

Editor’s Letter - Issue 122

A higher proportion of long only than hedge fund assets are publicly branded as being run on ESG (Environmental, Social and Governance) criteria, but that might change in future. The UNPRI (Principles for Responsible Investment) has finally unveiled a new due diligence questionnaire (DDQ) covering ESG considerations. AIMA, which has developed a suite of DDQs for over 20 years, belonged to the 17-strong working group as did the Hedge Fund Standards Board (HFSB).

The HSFB addresses some concerns around the G in ESG, through its support for fund and manager governance policies on conflicts of interest and valuation policies; reports such as administrator NAV transparency reports, and risk aggregation formats such as Open Protocol Enabling Risk Aggregation. Beyond this, governance at investee companies, and the E and S, are also attracting more interest.

The impetus for the DDQ comes partly from institutional investors. Albourne Partners started examining ESG more closely in 2011, initially in response to interest from allocators in Northern Europe and Australasia. Albourne now reports growing concern from the US.

Man Group’s GLG was an early mover. The firm has run a sustainability fund since 2008, and has been involved with the UNPRI advisory board. Man GLG’s approach avoids both “black boxes” and potentially simplistic box-ticking. “As managers have different styles the aim is to educate them internally and let them adapt,” says COO Carol Ward. Indeed, no one size may fit all. Many in the industry believe that DIY research is needed to complement various rankings supplied by providers such as Sustainalytics, Trucost or TruValue Labs. Additional research is essential partly because there are gaps in providers’ coverage, particularly in emerging markets and China, where disclosure can also be less extensive.

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