Use the Hedge-Fund Advantages - dummies

By David Stevenson

In their battles to improve shareholder returns, UK hedge funds face stiff competition from pension funds, corporate raiders and private equity groups keen to take their target company private – that is, get rid of its stock market listing. (Many corporate takeovers involve converting the company from a public to a private entity so that shareholders cannot trade their stocks in the open market; the raiders then restructure the company and reissue its stock after the company is profitable again.)

What are the advantages hedge funds have?

But hedge funds have one big advantage over their more conventional activist rivals – they don’t need to buy as many shares in a target company to effect change, largely because they’re subject to a smaller number of statutory regulations.

Unlike mutual funds (collective investment vehicles that are sold to the general public that limit the ownership of voting shares), hedge funds can hold more than 10 per cent of any firm’s stock and invest more than 5 per cent of their assets in any stock.

In addition, they aren’t required to have sufficient capital to cover redemptions and can restrict investors from exiting their funds – nor do they need to disclose their holdings, investment strategies, shortselling positions or leverage ratios.

Given these regulatory advantages hedge funds have over traditional institutional investors, all kinds of activists now call themselves hedge funds. You, too, can take advantage of these favourable rules. Just be aware that the very things that make hedge funds more flexible may also make them less transparent and, therefore, more risky.

How do hedge funds work?

After setting up their lightly regulated shop, the hedge-fund activist needs to start buying shares. Even at this step, hedge funds have an advantage.

Academics reveal the surprising conclusion that some of the most successful activist hedge funds own as little as 2 per cent of the shares of a publicly quoted company, although the most common stake is about 10 per cent. Therefore, to be successful an activist doesn’t have to deploy a huge chunk of capital to effect change in a company.

With these advantages to help them, hedge-fund activists are pretty successful in their stated aim of changing the direction of a company – and boosting the share price. In about 40 per cent of campaigns, hedge funds succeed in their stated aim of making a corporate change and in another 26 per cent they achieve partial success, gaining significant concessions from their targets.