Though executives and the media typically group hedge funds and pension funds into a single class of "institutional investors," there's increasing evidence that the two fund types are at odds. In recent conversations with Compliance Week, a number of pension- and union-fund managers admit they are uneasy with many of the tactics and goals of the more aggressive hedge funds—and they seek to distance themselves somewhat from the group.

“This is a growing debate within the shareholder activist community,” says Richard Ferlauto, director of pension and benefit policy at AFSCME, the union for government employees. “Our interests are not aligned.”

Edward Durkin, spokesman for the United Brotherhood of Carpenters, agrees: “I can’t point to anybody [among hedge funds] we’re on the same page with.”

Union funds say the main tension is their concern about the long-term health and viability of a company, versus hedge funds’ desire to reap a quick profit. Ferlauto and others stress that sometimes their interests do align with hedge funds, such as when both want to roust an unresponsive board of directors or a weak management team. But generally, they add, hedge funds’ short-term focus clashes with the interests of the unions and their members.

Union leaders assert that they invest with a 30- to 40-year horizon, and what might serve immediate interests of a company’s stock could ultimately hurt it down the road. Hedge funds “want to come into a company, turn things around, increase the stock price and get out,” sniffs Benny Hernandez, corporate governance adviser to the Sheet Metal Workers' National Pension Fund. “That’s not what pension funds are looking at.”

For example, if a company uses surplus cash or borrows money to award investors with a large dividend—precisely what hedge fund mogul Carl Icahn convinced oil and gas producer Kerr-McGee Corp. to do last year—the stock price typically bumps up and hedge funds can walk away with a big, quick gain. That payout, however, might be at the expense of future investment in research or equipment, and ultimately retard the company’s performance (and stock price) in the long haul.

“It’s problematic when they force companies to do things in the short-term that have lasting negative effects for the long-term,” Durkin says. He likens hedge funds to the corporate raiders of the 1980s—a group that counted Icahn as its chief member. “They have narrower interests than ours. When they are effective in changing corporate behavior, it is not always favorable from our perspective.”

Not surprisingly, hedge funds dispute that reputation. Barry Rosenstein, managing partner of the $5 billion Jana Partners fund, says his ilk are merely “doing what we should be doing: trying to maximize shareholder value.”

Jana Partners is working with Icahn now in his push to break up media behemoth Time Warner, which so far has failed to spark much success or increase in Time Warner’s stock price. Still, Rosenstein says it is a hedge fund’s job to fight for shareholder value and a board’s duty to listen.

HEDGE ACTIVISM

The excerpt below is from Citigroup's Sept. 2005 report, Hedge Funds At The Gate," which analyzed hedge fund behavior and offered recommendations for companies contending with the funds. The report and related Compliance Week coverage can be found below:

Forms Of Hedge Fund Activism

Hedge fund activism takes a variety of forms, ranging from changing management strategy through publicity, explicit pressure or collaborative dialogue with management, election of alternate directors with the intention to affect board decision making, or through a change in control of the targeted firm.... The fund’s objectives range from changing corporate governance and

financial policies to influencing the strategic positioning of the company through sale of assets or divisions, to influencing the sale of the company and/or replacement of

the management team.

Typically, a hedge fund will accomplish these objectives by first accumulating stock

in a targeted company to obtain a small foothold in the shareholder base. Once a

certain amount is obtained, the fund attempts to attract attention and publicity to the

company and the fund’s ownership of the stock. The public pressure and media

attention allows the fund to pursue its objectives more vigorously. Sometimes, other

hedge funds join the effort in an attempt to collectively obtain a larger percentage of

shares and thus wield more voting power. This can create a wave of buying by

various hedge funds that may collectively end up with a sizeable stake in the

company. Though it has not yet been tested in any live situation, it should be noted

that this teaming of different funds may avoid triggering the typical shareholder rights

plan (aka “poison pill”). Normally, any single entity that becomes the beneficial

owner of more than, for example, 15% of the company, risks triggering the dilutive

impact of the poison pill. In a teaming of hedge funds situation, an open question may

exist as to whether the funds are acting as a single person for purposes of a triggering

event. Poison pills, which have proven to be an effective deterrent to purchases by

aggressors above the “trigger point,” may prove ineffective, however, against a flock

of hedge funds entering the shareholder base of a target company far in excess of any

trigger threshold. Whether or not a target company is able to prevail in court, the substantial turnover in the shareholder base may render those arguments moot and the

poison pill essentially ineffective.

In many cases, funds seek to garner public and media attention to publicize weak

financial performance and/or other shortfalls of the target company management.

The publicity may be accompanied by the threat or attempt to launch a proxy fight

for board seats. In these cases, funds seek to change the company’s management

team or corporate policies...

Taking things a step further, funds will sometimes inject themselves into influential

strategic decisions such as asset sales...

Representing an extreme form of activism, hedge funds are also emerging as outright

buyers of targeted companies...

Some funds are developing extensive expertise in activism through repeated

targeting of companies. Perhaps the best known of these is Carl Icahn who has been

engaged in activist campaigns at numerous companies, including Blockbuster, Mylan

Laboratories, Scandia Forsak, Kerr-McGee, Temple-Inland, VISX, and most recently

Time-Warner. Though the most well known, Icahn is not alone in considering

activism as a distinct strategy for delivering returns. Other funds, such as Pirate

Capital, Opportunity Partners, Santa Monica Partners, and Burton Capital

Management have been involved in multiple activist campaigns over the past year...

Source:

Hedge Funds At The Gate (Citigroup's Global Corporate Finance Group; Sept. 22, 2005)

Related Coverage:

Report Profiles Hedge Fund Targets, Preemptive Steps (Compliance Week; Dec. 6, 2005)

“It’s very convenient to brand hedge funds as short-term, but I don’t think that’s the case at all… The things we are proposing go to the long-term benefit of shareholders,” he says. “The board’s primary fiduciary obligation is to the shareholders.”

Uneasy Alliances

To be sure, numerous hedge funds like Jana and Steel Partners regularly cite corporate governance changes as their motivation for change. Icahn has scorched Time Warner for excessive perks such as executives’ use of corporate aircraft, and previously made similar complaints when he held shares in Blockbuster Inc.

Pension funds, however, are skeptical. Many moves that hedge funds advocate often lead to an overall downsizing of the company—and that means loss of jobs, the very heart of union worries.

“We’re generally leery and concerned about that behavior,” Durkin says. In fact, even though Time Warner had been on the radar of the union activists long before Icahn’s arrival, and a number of union activists concede that they support some of Icahn’s demands, they stress that they don’t make it a practice to speak with the billionaire raider.

“I don’t want to seem like we’re aligned with Icahn,” says Ferlauto, who targeted Time Warner before Icahn jumped into the stock last summer. “I don’t want people to draw the inference that our view and his view are the same. We may target similar companies, but the solutions are not the same.”

“He looks to make a lot of money in a short period of time,” Hernandez says. “How sincere is he for the long term?”

Durkin says that while union activists have aggressively pushed for measures calling for more say in the director nomination process, they do not blindly support every so-called activist measure that crops up. For example, Durkin believes there are many reasons to support anti-takeover devices such as poison pills and staggered boards of directors, devices that the hedge funds and corporate raiders have roundly criticized over the years. ”We think in the hands of a good board, they could help a company so it is not constantly looking over its shoulder,” he says.

Brandon Rees, research analyst for the AFL-CIO Office of Investment, agrees, stating, “We would support management if we felt it was in the company’s best interests.” And while union activists say they do support proxy fights under certain circumstances, Rees stresses that “any proxy fight led by a hedge fund must be evaluated on a case by case basis.”

The divide between union activists and hedge funds, however, has become more complicated and murky in recent years as a growing number of large institutions place money with hedge funds. Many of these institutional investors are pension plans of state union workers, putting them at odds with trade union members. Union activists are well aware of the potentially sticky issue.

“It is interesting,” says Durkin, who acknowledges that sometimes pension fund activism itself is too short-term oriented. “It’s an issue that the activist community is dealing with,” Ferlauto adds.

Dealing with that issue may be difficult. Patrick McGurn of Institutional Shareholder Services explains that activism depends on attracting capital, so the hedge funds need the institutions involved. Noting the growing number of government pension funds that have invested with hedge funds, and are therefore aligned against the trade unions, McGurn asserts: “There is going to be a certain amount of irony here.”

Related coverage and columns can be found in the box above, right.

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