The existence of dual share classes offers arbitrage opportunities for hedge funds. Investors may be wise to take note as well. Here is how it works. Different shares of the same security often trade for slightly dissimilar prices because of a number of factors, including different voting rights, or the shares' relative liquidity.
Investors may want to consider taking a look at companies that offer share classes with different voting rights, such as
. "It happens that the holders of shares without supervoting power will pressure management to eliminate the unfair treatment," says one merger arbitrage hedge fund manager who requested anonymity.
When the pressure works, companies may buy back the non-voting shares at a premium or combine both share classes. In both cases, whoever bought the cheapest share class ends up winning.
Take the case of
, a Dallas-based company that manufactures cement and concretes. In January, Eagle Materials announced that it would reclassify its two classes of stock into one on April 11 at its shareholder meeting. The two share classes were created when the company was spun off from
For the past two years, the B shares (under the symbol EXPB) have consistently traded at a discount to the A shares, most likely because they are relatively illiquid compared with the A shares. Average volume for the past three months was 135,000 shares for Class B and 1.11 million for class A.
Before the January announcement, the B series were trading at a discount of 90 cents to $1.25 to the A shares, says Jerry Paul, founder of Quixote Capital Partners, a merger arbitrage hedge fund, who has been buying the cheap B shares over the past few months. "It's highly unusual when a company combines two share classes into one," says Paul, who took advantage of the arbitrage opportunity early on.
Now the profit opportunity measured by the spread price between the two share classes has narrowed, says Paul, and it looks like the arbitrage has lost its momentum. From over a dollar a few months ago, the price difference narrowed into a range of 10 cents to 15 cents last week. It was only a couple of cents on Friday.
In the Vault
Nothing seems to stop investors from throwing their dollars at brand new hedge funds that will lock up their money for years. Following in the footsteps of
luminary Eric Mindich last year and former Harvard endowment manager Jack Meyer earlier this year, a trio of former
equity traders just launched another big and illiquid start-up last week.
Old Lane, created by Vikram Pandit, John Havens and Guru Ramakrishnan, is a multi-strategy hedge fund that has already secured more than $3 billion in capital commitments, according to a person familiar with the launch. "You won't get your money for four years," adds this person, explaining that the fund carries a two-year "hard lockup" during which money may not be withdrawn. After that, the investor can only withdraw 50% of his money per year, so it will take an additional two years to pull it out entirely.
Why would people be willing to tie their money up for so long? It's all about who you are. In the case of Old Lane, the trio left Morgan Stanley last year in the midst of a management crisis that led to the removal of chief executive Philip Purcell. People know them as a team of superstar equity traders. Calls to Old Lane were not returned.
Not all investors are willing to put up with the hefty fees or the longer lockups imposed by hedge fund managers. Yale University Endowment, reportedly pulled out $500 million from London-based hedge fund The Children's Fund, which is commonly known as TCI. According to press reports, David Swenson, the famed Yale chief investment officer and one of the most savvy hedge fund investors in the country, did not approve of a planned 3% increase of the performance fee.
TCI is also a very popular fund known for its successful activism, notably its success at blocking a bid by Deutsche Boerse for the London Stock Exchange last year. Smart investors don't like to invest in funds that are too big. As the saying goes, size can be the enemy of performance. Calls to TCI and Yale were not returned.
Yep, It's Who You Know
Hedge fund activist David Nierenberg, who runs the D3 Family Funds, bought 5% of
Credence Systems Corp.
( CMOS), a provider of design-to-test solutions for the semiconductor industry, because he likes the new executive chairman of the board, David House.
Nierenberg likes that House spent 22 years in management roles at
. But the key factor here was reputation. "We had the opportunity to check out Dave pretty well during his time at Intel because he was a business partner of a senior executive who happened to be an investor in our fund," Nierenberg told
. "In the next six months, if the stock delivers a bargain, we'll consider adding even more shares," he said.
Billons and Billions
Global assets in hedge funds have now reached more than $1.5 trillion, according to a new research by HedgeFund Intelligence. The study found that U.S. hedge funds with more than $1 billion in assets now amount for more than $850 billion, and that's just for the U.S. The smaller U.S. funds have reached $200 billion.
Abroad, European funds represent $325 billion, Asian funds have passed the landmark of $100 billion and other regions, such as Canada, Brazil or South Africa, account for $50 billion. The study was completed in February.