Capital deployed by activist investors is growing and has important implications for Board competence and composition. Not least because activists may seek Board seats and/or Board refreshment. Fidelio’s focus is building Boards fit for the future and activism shows no sign of abating.
Structural factors within the investment management industry are driving polarisation in investor strategies with active managers becoming more active to counter the growth of passive funds. Board Members need to be prepared to respond constructively if their company becomes an activist target; more importantly Board composition that is evidently aligned with strategy and drives strong performance will deter activists in the first place.
In Fidelio’s Board Search and Evaluation assignments we clearly see the impact and awareness of activism. Board composition can easily become the chess board of the activist’s game. Activism is equally on the Board Development agenda with Fidelio seeing wise Chairs preparing their Boards before the activist is revealed on the register.
Why Activism is here to stay
Long a stable and highly profitable business, the investment management industry is undergoing wrenching change driving lower returns. Low-cost passive strategies – portfolios or funds that aim to replicate a specific stock market index – are growing rapidly and a combination of patchy performance and high fees leaves the business case for many active portfolios looking threadbare. Historically low interest rates lead to a thirst for yield, and a long period of strong equity performance behind us combined with an uncertain economic future only increase the challenge.
This reshaping of the investment landscape was recently depicted clearly by Sarah Bates, Chair of Merian Global Investors, who also identified consequences for companies, Boards and IR teams. Similarly Edward Bonham-Carter, Vice Chairman of Jupiter Fund Management plc, will explore the implications of these structural shifts for Boards and their shareholders at Fidelio’s upcoming Board Breakfast, “Boards, Governance, Shareholders and Asset Management”.
Investment managers are faced with a choice between two basic strategies: either play the passive game, largely one of scale, broad retail distribution, and low cost; or offer more targeted portfolios that seek superior performance by investments in particular asset classes such as property, infrastructure and private equity, or by pursuing highly differentiated listed equity strategies. The last of these may include hedge funds – a category that includes a wide range of investment approaches – and activist strategies, broadly defined as investing with an intent to drive change in target companies. In 2018 activists initiated a record number of campaigns and deployed more capital than ever before, and it appears likely that 2019 will continue the trend.
Activist Diagnoses and Prescriptions
“Activists wield disproportionate power because the ownership of big firms has polarised. On one side is the lazy money….. At the other end of the spectrum is the bossy money.”
Activist styles vary. There’s a continuum from the controversialists often found in the press to the quieter type who prefer engagement with the Board behind the scenes before going public. The extent to which activists employ leverage and derivatives also varies but the activist diagnostic tool for identifying opportunities is consistent. Frequently a company targeted by activists:
- Is underperforming its peer group in terms of operating profitability
- Is valued by the stock market at a significant discount to its peer group
- Has a Board that is not aligned to the strategic goals nor seen to be addressing underperformance
- Faces structural cost challenges which it has so far failed to tackle
- Has a conglomerate structure without clear strategic logic
- Has underperforming divisions outside of its home geography or original business type
- Is under-leveraged
- Is accumulating cash without a clear reinvestment plan
- Appears cheap relative to global peers with market and currency volatility arguably putting companies into play
Similarly, the activist’s recommended treatment is likely to involve operational and financial engineering, as well as leadership refreshment, along the following lines:
- Disposal of non-core assets or divisions
- Breaking up the group in search of a higher stock market valuation
- Refreshment of the Board and leadership team
- A restructuring programme aimed at cost reduction
- Measures to increase borrowing and return the cash to shareholders
- Share buybacks
- Increased dividend payments
The Pre-Emptive Strategy: High-performing Boards keep Activists at Bay
Board responses to activism are frequently marked by a defensive tone, but by far the best strategy for dealing with activism is ensure the company is unattractive as a target in the first place. If Boards ensure the following are all in place, they are unlikely to fall prey to activists – and they will also ensure a full valuation for all shareholders in the event of a sale or takeover:
- Strong financial performance
- Solid stock market valuation
- Board composition evidently aligned to strategy
- Genuine Chair and Board responsiveness to shareholders and stakeholders
- Effective Investor Relations
Board Effectiveness and Robustness – Keys to Success
While the results outlined above are clearly effective in averting activism they are clearly easier to talk about than to deliver. The list of essential ingredients starts with a fresh and engaged Board who bring a range of skills and experience closely relevant to the execution of the company’s strategy. Building an effective and pro-active Board has to be the first priority of the Chair. The Board is an important line of defence with regard to activism; more importantly it is the cornerstone of success.
Clearly external Board Evaluation should provide an important diagnostic tool for the Chair in identifying the robustness of the Board against the metrics set out above. The importance of external Board Evaluation is set in the UK Corporate Governance Code but Fidelio increasingly sees Chairs across a range of jurisdictions adopting this governance tool to enhance the effectiveness of the Board and as a driver of valuation.
And last but not least wise Chairs are ensuring that their Boards are prepared and understand how best to respond to an activist on the register. This preparation is becoming a standard component of Board Development and once again represents an important module in Fidelio’s forthcoming “A Seat at the Table” Board learning Programme.
To discuss how Fidelio can support with regard to Board effectiveness and Board composition, please contact Gillian Karran-Cumberlege on gkarrancumberlege@fideliopartners.com.