Exploring Links Among Long-Termism, Activist …...Exploring Links Among Long-Termism, Activist...

Exploring Links Among Long-Termism, Activist Behavior, And Shareholder Return

Insights on Long-TermismMay 02, 2016

Key Findings

– Enhanced Return On Invested Capital (ROIC) is a key driver of shareholder value.

– Stocks displaying the highest combined degree of improvement in ROIC and activist share ownership significantly outperform the broad market.

– Activist investing is increasingly becoming a style of management decision-making, essentially a behavior, as opposed to the traditional archetypical investor class.

– It is not appropriate to paint all activist investors with a single brush.

– Despite activists’ tendencies to draw attention to themselves and make headlines in the large-cap portion of the stock market, a preponderance of activists prefer to operate in the mid-cap category of the market.

– As an investor class, activist investors appear to be actively managing portfolio risk as much as they are reputed to be addressing long-term corporate operational issues.

The notion of long-termism, or the premise that corporate governance should always prioritize the long-term best interests of shareholders, is frequently perceived to be at odds with the objectives of activist investment funds. This is because the behavior and priorities of the activists are often seen to be aimed at short-term gains and opposed to the behavior exhibited by existing executive management.

Activist investors are often criticized in financial media for allegedly pushing management to increase balance sheet leverage in order to repurchase stock or advocating for corporate actions such as mergers, acquisitions, or spin-offs that are not necessarily in the best long-term strategic interest of the company. Activists might then counter that they are only seeking to optimize the organizational or capital structure of the targeted company because existing management has been reluctant to do so.

To gain insights into how executives should be managing corporations with the long-term interests of shareholders in mind, S&P Global Market Intelligence first investi-gates return on invested capital (ROIC) as a broad benchmark of corporate operating efficiency for companies. The following data and analysis is based on all constituent companies between 2004 and 2015 that compose the S&P 1500 equity index, which includes small-, mid-, and large-cap equity corporations.

May 02, 2016 | S&P GLOBALExploring Links Among Long-Termism, Activist Behavior, And Shareholder Return 3

Table 1

Excess Return Above S&P 1500 Index--Based On Quintile Rank Of Annual ROIC Improvement--Forward years (%)--

Quintiles 1 2 3 4 5

1 3.51 2.78 2.38 2.03 2.66

2 2.84 2.71 2.87 3.32 3.93

3 2.94 2.61 2.97 3.79 4.60

4 1.66 1.79 1.74 2.48 3.37

5 (0.34) 1.56 1.55 1.81 2.78

Statistical significance 5.00 5.00 10.00 N.M. N.M.

ROIC--Return on invested capital. N.M.--Not meaningful. Source: S&P Global Market Intelligence.

Table 2

Excess Return Above S&P 1500 Index--Based On Prior Year-End Quintile Rank Of Activist Ownership

--Forward years (%)--

Quintiles 1 2 3 4 5

1 3.31 3.86 3.81 4.43 5.45

2 3.05 2.71 2.99 3.30 4.20

3 1.79 1.95 1.59 2.03 2.53

4 2.38 2.18 2.00 2.43 2.97

5 0.46 0.79 0.78 1.15 1.90

Statistical significance N.M. N.M. N.M. 5.00 5.00


Annual rates of ROIC improvement are positively correlated with above-market rates of return. Among S&P 1500 equity index constituent companies, the larger the yearly ROIC improvement, the greater the level of stock outperformance versus the broad market. This is true in the forward one- to five-year equity price performance timeframes (see table 1).

Individual stocks with higher degrees of activist ownership also exhibit above-average positive rates of return. In almost all cases, the higher the annual activist ownership rank, the higher the excess return (above the return of the S&P 1500 index; see table 2).


Table 3

Excess Return Above S&P 1500 Index--Based On Quintile Ranking Of Activist Ownership Combined With ROIC Improvement

--Forward years (%)--

Quintiles 1 2 3 4 5

1 4.02 3.13 3.45 3.79 4.50

2 4.29 3.52 3.44 4.00 4.75

3 2.11 2.21 1.94 2.15 2.62

4 2.77 2.70 2.25 2.60 3.24

5 (0.69) 0.41 0.38 0.74 1.22

Statistical significance 5.00 1.00 1.00 5.00 1.00


Stocks displaying the highest combined degrees of activist ownership and ROIC im-provement outperform the broad stock market by significant margins, again in nearly perfectly sequential order.

The higher-ranked stocks according to activist ownership and ROIC improvement rank clearly outperform whether measured on a forward one-year or the significantly longer five-year forward timeframe, based on quintile rankings of observed data between 2004 and 2015 (see table 3).

To be sure, the single ROIC statistic may not capture everything that executive manage-ment implements while seeking to enhance shareholder return; nevertheless, these largely significant correlations suggest a definite link between improving corporate efficiency and stock price outperformance for up to five years into the future, which is consistent with the notion of long-termism.

Although we were not able to directly identify significant positive correlations between activist ownership as a direct driver of improvement in ROIC, both characteristics have share price outperformance in common.

The elevated portfolio turnover characteristic of activist holdings may be impeding the identification of a direct correlation between activist holdings and ROIC. However, activist investor influence could remain even as the fund manager periodically moves in and out of the stock, either outright or as a percent of total portfolio exposure.

The Long- And Short-Term Traits Of Activist Investors

Having established annual rates of ROIC improvement as a driver of shareholder value, it is interesting to note that activist investors are typically viewed as change agents. By purchasing a large percentage ownership of a company’s stock, activists seek to influence corporate management in a way that improves the company’s operating efficiency and increases the value of the original investment.


The data sample for the analysis that immediately follows includes all activist investor individual stock positions in companies having a minimum $1 billion market capitalization. The companies also have met at least one of the following additional conditions between 2004 and 2015: The cumulative activist investor equity position must constitute at least 10% of the activist’s total portfolio value or a minimum of 5% of the company’s market capitalization of shares outstanding. This 10% portfolio-based criteria seek the inclusion of many large-cap (greater than $10 billion) and mega-cap (greater than $50 billion) corpora-tions that are too large to meet the traditional 5% ownership stake typically used to identify activist participation. To provide a more detailed perspective on activist investor behavior, additional insights are provided at the 1% and 2% portfolio exposure criteria level.

Chronology of activist investor market participation

Aggregate activist holdings ballooned to $133.5 billion at year-end 2015 from $58.5 billion in 2004, representing 128% growth.

The number of significant equity positions held by 87 investors identified as activists by S&P Global Market Intelligence data has risen by 65% to 280 at year-end 2015 from the 170 posi-tions held by 47 activists in 2004 (see table 4).

Despite the steady growth of the activist investor community and associated cumulative portfolio holdings over the past decade, activist-owned stocks still constitute a small percent of the broad market. As of year-end 2015, total 5%/10% criteria sample holdings equaled just 0.6% of the market capitalization of the S&P 1500 equity index. If we expand the activist ownership sample to include all holdings (with a minimum of $1 billion market capi-talization) representing at least 1% of the activist firm’s total portfolio, total holding would still sum to a miniscule 1.1% of the S&P 1500 index.

Table 4

Annual Activist Stock Ownership – 2004-2015 5%/10% Criteria Sample

# of companies invested Aggregated value holdings (mil. $)

2004 170 58,489

2005 200 91,131

2006 242 114,634

2007 266 128,543

2008 193 67,052

2009 198 91,740

2010 239 111,912

2011 236 94,146

2012 232 92,754

2013 271 128,390

2014 314 153,989

2015 280 133,482

Source: S&P Global Market Intelligence.


Where do activist investors operate (based on equity market capitalization)?

Activist Stock Ownership By Market Capitalization

Companies designated as mid-cap stocks, with equity market capitalization between $2 billion and $10 billion, were the most popular activist investor targets at 43.1%, followed by large-cap stocks at 30.6% and small-cap stocks (less than $2 billion) at 26.3% (see chart 1).

Of the 738 corporations within the large-cap category that have significant activist exposure, 202 (27%) had a market capitalization in excess of $50 billion (1% activist portfolio representation sample threshold).

Large-cap 30.6%

Mid-cap 43.1%

Small-cap 26.3%

Chart 1

Source: S&P Global Market Intelligence. © S&P Global Market Intelligence 2016.


For perspective, if we widen the universe of activist investor positions held to in-clude just 2% of the activist’s total portfolio, for companies with a minimum $1 billion market capitalization, the large-cap holding category increases by just over 10% from the aforementioned levels largely at the expense of the small-cap stock holding category (see chart 2).

The fact that the smaller portfolio percent threshold sample (chart 2) shows in-creased participation in large-cap stocks that offer greater liquidity may suggest that this market capitalization class of exposure is more of a short-term trading vehicle opportunity. This is borne out by the observation that two-thirds of the 2% threshold activist positions are exited or reduced from that level within two quar-ters, after the position reached that threshold for inclusion (see chart 4).

Large-cap 30.6%

Mid-cap 43.1%

Small-cap 26.3%

Activist Ownership, 2% Portfolio Ownership Threshold

Chart 2

Source: S&P Global Market Intelligence. © S&P Capital IQ 2016.


How Long Do Activist Investors Hold Significant Equity Market Positions? Activist investors, on average, tend to hold significant equity positions (a minimum 5% of shares outstanding or 10% of the activist’s total portfolio) for a relatively short period of time.

Forty percent of activist investor stakes are reduced or, in some instances, completely eliminated in the quarter after the significant position was identified according to our methodology (see chart 3), but this does not mean that all activists are short-term-oriented. Of the 2,414 individual activist equity positions that met our definition for standard of significance between 2004 and 2015, 160, or 6.6%, had a holding period of three years or longer as of year-end 2015. For significant activist holding periods of one year or longer, this statistic increased to 610 of 2,414, or 25% (see table 5).

Additionally, activists often maintain positions in their target companies for many years after their holdings have subsequently slipped below the standard of significance established for this large data format investigation. In many cases, this can be inter-preted as maintaining a smaller, less significant but still sizable position in the company after the larger position successfully enacted the desired operational changes when the activist wielded maximum influence.

Activist Holding Period, 5%/10% Criteria Sample

More than 12 quarters 6.6%

Five to 12 quarters 18.6%

Three to four quarters 16.2%

Two quarters 19%

One quarter 39.6%

Chart 3



Table 5

Length Of Activist Holding Period--2004-2015

Small-cap (no. of companies) Mid-cap (no. of companies) Large-cap (no. of companies)

636 1,040 738

One quarter 217 394 344

Two quarters 96 194 169

Three to four quarters 108 172 110

Five to 12 quarters 154 210 86

More than 12 quarters 61 70 29


More than 12 quarters 2.8%

Five to 12 quarters 13.9%

Three to four quarters 15.9%

Two quarters 18.9%

One quarter 48.5%

Activist Ownership, 2% Portfolio Ownership Threshold

Chart 4



Notable Activist Holdings As Of Dec. 31, 2015 Reviewing year-end holdings (from activists who have reported them), we looked at the companies attracting the greatest interest from activists. Again, we only included companies with a market capitalization in excess of $1 billion. Table 6 lists the 10 companies with the largest activist participation in which the position represents at least 1% of their portfolio value contrasted by the number of activists meeting the standard for inclusion as a significantly large and influential position.

Many investors identified as activists may not have the resources to amass a stake large enough to influence the decisions of executive management. Although all of the companies above have attracted investments from up to 20 activist investors, in eight of 10 cases, the participation drops down to one to three activists after applying our criteria for a significant and influential position. Table 7 provides perspective on the top activist investors according to positions meeting the aforementioned standard of significance and potential influence. Some of these activists are frequently observed in financial media commenting on their holdings and market expectations, while other activists prefer to work more quietly with management when looking to effect change.

Table 6

Companies With Notable Activist Holdings

Activist name Activists with stock at least 1% of activist portfolio (no.)

Activists with at least 5% shares outstanding or 10% of activist portfolio (no.)

Alphabet Inc. 20 2

Allergan PLC 17 4

Yahoo! Inc. 14 3

Microsoft Corp. 13 2

Time Warner Cable Inc. 11 4

EMC Corp. 10 3

Citizens Financial Group Inc. 10 1

Broadcom Corp. 9 3

Valeant Pharmaceuticals International Inc.

9 2

Williams Companies Inc. 9 1



Table 7

Top Activist Investors As Of Dec. 31, 2015

Activist name Value of holdings (mil. $) No. of holdings

Icahn Capital L.P. 24,185 17

Trian Fund Management L.P. 11,896 8

Pershing Square Capital Management L.P. 11,081 8

ValueAct Capital LLC 8,769 8

Third Point LLC 6,804 6


Concluding Thoughts

It is not appropriate to characterize all activist investors the same way. Although many activists are quick to exit or significantly reduce their positions after just a single quar-ter, others commit to owning shares of the target company for one to three years and considerably longer in many instances. However, on average, activist investors hold significant positions in individual companies for a much shorter time period than the tenure of senior executive management at those firms. As of April 6, 2016, of the 1,474 companies having CEO start-date data for companies included in the S&P 1500 index, the average CEO tenure stands at 7.8 years, inclusive of the 60 CEOs that entered that position since the start of 2016, according to S&P Global Market Intelligence data. This observation suggests that the interests of the activists may not be perfectly aligned with that of executive management and other long-term shareholders.

Furthermore, it appears that “activist” investing in recent years has become more of an investment or corporate management style, or behavior, as opposed to the classic definition of an investment fund that seeks to influence management decision-making via the brute force clout of portfolio investment. Evidence of this includes today’s widespread use of stock buybacks and capital market activity such as mergers and spin-offs--all basic plays in the activist investor playbook--as a means of optimizing corporate efficiency and delivering enhanced shareholder value (see charts 5 and 6).


Chart 5

Announced Mergers And Acquisitions By S&P 1500 Companies

0

100

200

300

400

50

150

250

350

1Q161Q15

1Q141Q13

1Q121Q11

1Q101Q09

1Q081Q07

1Q061Q05

1Q041Q03

1Q021Q01

1Q001Q99

1Q980

100

200

300

400

500

(Bill. $)

Total deal value(left scale)

No. of deals(right scale)

No.

50

150

250

350

450


Chart 6

S&P 1500 Announced Buybacks

0

100

50

150

250

0

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80

120

160

(Bill. $)

Value(left scale)

No. of announcements(right scale)

No.

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140

1Q161Q15

1Q141Q13

1Q121Q11

1Q101Q09

1Q081Q07

1Q061Q05

1Q041Q03

1Q021Q01

1Q001Q99

1Q98

200



Because of the high portfolio turnover rates of activist holdings, it is difficult to identify correlations or draw conclusions about the direct cause-and-effect relationship between activist ownership and subsequent corporate actions, such as share repurchases, merger and acquisition activity, or debt issuance trends relative to the broader stock market. Our sense is that these tactics have become so widespread within corporations that it is difficult to conclude that activists are driving above-trend rates of buyback or capital market decision-making.

Additionally, at what point does an investor’s equity position become influential and of a true “activist” nature? A 0.5% stake in a mega-cap corporation can, in many cases, be much more influential than a 5% stake in a small- or mid-cap holding with the smaller percentage stake but larger notional currency exposure resulting in representation on the company’s board. Alternatively, a position in a much smaller market capitalization stock, especially if it is fairly short-term in duration, might just be a distraction to executive management depending on the investor’s nature.

There is also the notion of an activist identifying a company that it thinks is already operating close to peak efficiency, in which the activist’s intention is simply to closely monitor the executive management team to ensure that the company stays on the current path. These are examples where current management has already adopted an activist style of company management that has optimized share price performance and attracted activist investors.

Conversely, there are also likely many examples in which activist investors pursue a more aggressive role, perhaps involving the company taking on greater leverage, buying back shares as opposed to retiring or restructuring debt, and engaging in mergers or spin-offs that may not be the preferred current direction for existing management and board members. This is where questions can arise addressing the short-term versus long-term motives and ambitions of the individual activist fund manager.

The data and observations we have highlighted suggest that it is preferable to evaluate each activist individually according to its specific track record of working in line with, or opposed to, the long-term interests of all shareholders, no matter how small (retail) or large (institutional) the investor.

While it is often the larger market capitalization activist holdings that attract the most attention from the media, which helps drive public perceptions about the activities, tactics, and motivations of activist investors, our data review shows that when it comes to significant portfolio holdings, less than one-third have occurred in the large-cap space over the past decade.

The generally lackluster longer-term holding period performance characteristics of large-cap activist holdings can help explain some public criticism of activists as being short-term-oriented, but this does not appear to be a characteristic of the small- and mid-cap holdings. Furthermore, the nominal number of large-cap holding events in excess of three years is much less statistically compelling than the lower capitalization observations.


Many activists operate well below the 5% ownership threshold typically associated with an influential ownership stake, and a good number of activist funds are fairly nimble, often appearing to be fairly short-term motivated according to aggregated holding period data. Therefore, the activist community at large may be striving to actively manage portfolio risk and return to the same extent it is looking to influence corporate decision-making.

Alternatively, a fairly significant portion of activist investors exhibit longer duration interests in the company being targeted, suggesting what are often positive and generally constructive links between the interests of the activists and long-termism.

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