Hedge Fund Activism and Takeovers

Hedge Fund Activism and Takeovers

Due to market efficiency, creating arbitrage profits through trading and investing has become more and more unrealistic. Because of this, investors need to search for additional ways to create abnormal profits through their investments. In order to do so, investors are now looking to behavioral and managerial methods to create these returns. We believe that investing into firms that hedge funds are targeting for activism can make substantial profits.

In order to first understand our strategy, it is important to recognize how hedge fund managers use activism to produce these abnormal returns. Activism refers to the intention to increase value of a firm by improving the firm as a going concern. Activism can refer to firing management or adjusting the operational, financial, or government reforms. Statistics illustrate that these hedge fund managers are most successful in generating these returns only when they are able to influence control within an organization. This leads to the belief that hedge fund managers may be superior to other shareholders in relation to monitoring management. Previous knowledge alluded that hedge fund managers were skilled at inducing operational change, however according to “Investor Activism and Takeovers”, it is apparent that this is negligible in relation to hedge fund managers’ success at generating abnormal returns.

The article “Investor Activism and Takeovers” outlines the hypothesis that abnormal returns from activism are driven by the activist’ success at getting target firms taken over. These hedge funds are skilled at getting firms taken over through marketing techniques, as well as targeting firms that are “digestible”. Digestible companies are “companies that are easy to market as potential takeover targets” (363). These hedge funds tend to target firms with relatively low analyst coverage, are under performing the market, and generally have low valuation ratios. The idea behind this is...