What Activist Hedge Funds Are and How You Can Benefit

NEW YORK (TheStreet) -- In the last decade, activist investment has emerged as one of the most successful and fastest growing strategies in the hedge fund space. Over the last five years, assets under management (AUM) for activist funds have grown at over twice the rate of other hedge funds and consistently outperformed the S&P 500, according to a recent report from Schulte Roth & Zabel, a law firm that tracks the hedge fund industry.

While most investors are at least vaguely aware of activist hedge funds, seeing high profile coverage of Carl Icahn going after Apple (AAPL) and Bill Ackman's play on Allergan (AGN), many may not know exactly what most activist funds do, who they are or the sheer number of them out there. But for each loud campaign covered in the media, there are a dozen quiet ones happening at any given time. Beyond the sensational headlines, the activist space represents a rapidly growing strategy.

Further, there are both direct and indirect ways for shareholders to benefit from activist strategies, so the savvy investor would do well to pay attention. For a series of articles, of which this is the first, we sat down with activists of various sizes to get a sense of their views on the macro landscape, how the business is evolving, and how investors can benefit. This first article delves into how activism works behind the headlines, examines its real impact on shareholders, and distills practitioners' insights into actionable investment ideas.

What Is Activism?

At a high level the idea is simple: The activist identifies a company with unrealized value that it believes can be unlocked, and seeks to release that value by working with management and other shareholders, or in some cases advocates for a change in management direction. The activist profits from the appreciation of shares that it acquires leading up to its campaign.

The strategy is, at its core, a value investment strategy. The key difference that has made activist funds increasingly popular is that it not only identifies undervalued public companies, but moreover expends its own resources to actively unlock that value to the benefit of all shareholders.

Tailwinds Pushing the trend

This latter point -- that the value unlocked by activists is enjoyed by all shareholders and not just the fund -- has made activists a natural ally of institutional and individual investors alike.

So much have investors embraced the trend, that activists report being frequently contacted by investors and institutions trying to encourage a campaign. Because passive investors are typically the largest holders of stock, increased acceptance of activism by these key players has been critical to its growing success.

According to the Schulte Roth & Zabel report, Among the institutions that most consistently backed activists in proxy contests in 2014: BlackRock (BLK) ($4.655 trillion AUM), AllianceBernstein (AB) ($474 billion AUM), TIAA-CREF ($840 billion AUM), and Florida State Board of Administration ($177 billion AUM).

Regulators, too, are aware of and receptive to the shareholder democratization trend that activists represent. In 2013, SEC chair Mary Jo White noted that activism has led boards to make "...a concerted effort to persuade shareholders of the wisdom of management's choices and practices." The SEC chari characterized this as a good thing, and investors pushing up activists' AUM seem to agree.

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