How Active (Not Activist) Investors Create Real Value
This article originally appeared in Forbes on Feb. 11, 2015.
By Sally BlountMost chief executives and board directors cringe when they hear that an “activist investor” has taken an interest in their company. They imagine a brash, media-savvy vulture, followed by an aggressive pack of institutional and hedge fund investors, all demanding board seats, wanting to increase leverage and push for rapid spending cuts, spinoffs, and cash payouts—all in the interest of juicing short-term returns.
Think of companies like JCPenney, eBay, and Herbalife, where activist investors have come and created havoc, only to walk away. Even DuPont, a strong-performance Fortune 100 company, has been under attack since late last year, despite its announcement that it plans to spin off its chemical business.
The trend is getting so pronounced that Wall Street icons like Larry Fink, CEO of BlackRock (the world’s largest asset manager), and corporate attorney Marty Lipton have in recent months publicly decried activists aiming for fast returns. Citing the cuts in research and development spending, workforce development, and new technologies that short-termism typically brings, Lipton writes that “there is a growing recognition of the adverse [long-term] effect of these attacks on shareholders, employees, communities, and the economy.”
Last week Kellogg alumnus Jeff Ubben, CEO of ValueAct Capital, came to the Kellogg School’s campus to talk to our students about investing. Agreeing with Fink, Lipton, and others that short-term activism is not the answer, Jeff’s message was nuanced but clear.
Not all active investors are activists. Ubben argued that there is a meaningful role that well-informed investors with long-term stakes in a company can play in evaluating the actions of management. “There’s no way that a board made up of active CEOs meeting only six times a year can have all the bases covered” on behalf of investors, he said. But a long-term investor with a team of full-time analysts who actively watch an investment and monitor the activities of key competitors can. “That’s the value that an active large-scale investor can bring to a board seat.”
Exiting a stock is an inefficient way for long-term investors to voice their concerns to management. Quoting from the economist Albert Hirschman’s famous 1970 treatise, Exit, Voice, and Loyalty, Ubben explained how frustrating it had been when, as a fund manager at Fidelity, he had taken a large long-term position and found himself disagreeing with the CEO on a key decision only to be told, “If you don’t like it, sell your stock.” He felt that there had to be a “better way than exit,” a way for “an investor to engage in deeper conversation and problem solving” with management, because, he said, “we have the same goals, after all.”
True value-creation requires focus and patience. Because of that Ubben argues not for activist investing, where headlines, heated debates, and questionable outcomes rule, but for active long-term investing characterized by three principles:
1. Simplify. ValueAct doesn’t look at every business as an investment opportunity. It keeps it simple by focusing on a certain type of company. Specifically, Ubben looks for companies that are easily analyzed, participate in a consolidated industry structure, are embedded in the workflow of their customers, and offer a product or service that is a small part of the customer’s overall cost structure. Think Adobe Systems and Photoshop.
2. Go deep. Looking at either a company or an industry, Ubben believes in going deep and staying the course. He’s not interested in securing stakes in hundreds of businesses. He prefers to focus, like Warren Buffett and Lou Simpson, investors he admires deeply and who only hold 10 to 12 positions at a time. ValueAct doesn’t surf the trends, even though not getting distracted by them can be difficult. Instead, Ubben advocates the benefits of being consistent in thought and action. And by narrowing its focus, ValueAct is able to become a true expert in what matters most to the companies it considers—their business models.
3. Be patient. It’s not often that you get the “trifecta,” Ubben said—“a good business with good management at a good price.” More often you buy into a good business that’s been poorly managed. But that doesn’t always mean it has bad managers. Sometimes CEOs and boards just need to know that shareholders will support actions that create short-term losses if they can see that they are in the long-term best interest of the company. So ValueAct is willing to wait a bit longer for a return. That may sound contrary to most investor desires, but really it’s about prudent risk-taking. If the firm can see a path to get to the “promised land,” a long-term 20% compounder, then that allows it to stay invested and avoid reinvestment risk. So in the truest sense of the term, patience pays off.
When Ubben invests in a company, he’s a believer. He buys in, holds on, and stays engaged. And it works. ValueAct Capital’s net annualized return of approximately 17% over the past 14 years lends support to the power of these very basic principles.
Maybe more activist investors should take note.
- Sally Blount is dean of the Kellogg School of Management at Northwestern University.