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Activist Hedge Funds Research Team | Posted On Wednesday, April 15,2009, 06:21 PM

Activist Hedge Funds



Hedge funds are unconscientiously regulated private investment funds that use unconventional investment strategies and tax shelters in an effort to make extraordinary returns in any market. Characteristically, these funds are ordered as limited partnerships and limit investment to business or institutional investors. These factors have specified them a secretive and shady aura in the financial community; nevertheless, SEC rules and regulations make it promising for anyone to take a glance into their activities. This article will investigate how savvy individual investors can profit off of some of Wall Street's most brutal hedge funds.

Step 1: Find a hedge fund to watch

Most hedge funds invest using exceptional strategies, excluding others take a more active role in realizing the value in their investments - these are called as activist hedge funds. Activist hedge funds not only fit into place the company's board and management in discussion, nevertheless also wage proxy battles, liquidate assets and even force sales of companies. These activities can offer opportunities to savvy individual investors eager to do a little digging!

Those who have spent a little time in the marketplace may be recognizable with many of the activist hedge funds out there. Some funds are very public when fighting management, while others are tremendously quiet concerning their activities

Step 2: Tracking hedge funds

Hedge funds may be mystifying on the surface; nevertheless, the U.S. Securities and Exchange Commission (SEC) mandates an assured level of transparency - predominantly when activist hedge funds are involved. It's through these SEC filings that we can get a quick look into the proceedings being taken by activist hedge funds. You can find SEC filings by means of the official EDGAR database or other kinds of free services like SECFilings, which allow you to set up email and RSS alerts to also to send notifications when hedge funds make trades.

The most imperative form filed by activist hedge funds is the SC 13D, which is a proclamation of advantageous ownership (5% or above). There are numerous sections within this filing that can clue us in to the hedge fund's motivations and achievable future actions:

  • Security and Issuer: This contains basic information concerning the stock and associated company. 
  • Identity and Background: This section contains information regarding the hedge fund acquiring the stock, together with a disclosure of its criminal record and any pending lawsuits. 
  • Source, Amount of Funds and Other Considerations: This segment explains where the funds used to buy the stock are coming from (cash-on-hand or debt).
  • Purpose of Transaction: This is the most significant section of the SC 13D; it details precisely what the hedge fund is planning to do with its investment. A hedge fund is necessary to disclose whether it is holding stock merely as an investment, or if it is interested in "seeking strategic alternatives". 
  • Interest in Securities of the Issuer: This segment discloses the number of shares owned and intermittently the transaction dates for major purchases.
  • Material to be Filed as Exhibits: This is the second most significant section of the SC 13D; it contains any letters to management or other exhibits that often restrain tremendously useful information detailing future action.

Mutual, this information can give individual investors a lot of imminent into what the hedge fund is attempting to do with its investment, and whether it will be attempting to take over the company or is merely looking for a good investment.

Step 3: Deciphering a Hedge Fund's Activity

The "Purpose of Transaction" section of the SC 13D filing with the SEC describes accurately what the hedge fund is preparation to do. There are two different kinds of burden that hedge funds make in these letters:

Demands to the Board: 

These are unambiguous requests made to the board of directors demanding certain changes. These may comprise management replacements, mergers or acquisitions, capital structure changes, expenditure of cash reserves and other items.

Appeals to hareholders:

These are situations in which the hedge fund is looking to take over the company via an alternative battle. This is a circumstance that needs shareholders to vote to sign-on the hedge funds nominees as a substitute of the company's incumbent directors.

Activist hedge funds engage in many activities to unlock shareholder value, including:

  • Management replacements/changes
  • Potential mergers or acquisitions
  • Capital structure changes
  • Expenditure or executive compensation cuts
  • Disbursements of cash reserves to shareholders via dividends, buybacks, etc.

On the whole, this section of the SC 13D filing gives you all the information you need to know about the circumstances. Most of the time, these hedge funds have nothing to hide, since, they want investors to appreciate how management is failing.

Step 4: Acting on the iformation

There are two types of opportunities that activist hedge funds create:

 (1) Long-term turnarounds or

 (2) Short-term exit strategies.

 Apparently, the short-term actions are most beneficial to those following hedge fund activities since they provide the largest returns in the shortest possible amount of time. This is predominantly true for buyouts since they always happen at a premium to the market price.

Here are some common hedge fund activities and their general payoff times:

Short-Term Activities:

  • Sale of the company
  • Liquidation of assets
  • Special dividends 

Medium-Term Activities:

  • Replacing board members
  • Firing management

Long-Term Activities:

  • Share buyback programs
  • Small dividends
  • Capital structure changes 

It is significant to think about all of these things before following a hedge fund. Keep in mind that in approximately all cases, a fund will have averaged in at lower prices than yours, causing the potential for a large dissimilarity in breakeven points.

Even though investing alongside hedge funds isn't a confident way to make money, it is an enormous way to find opportunities. By cautiously analyzing the terms of the deals and proposals, it is potential for savvy investors to find eye-catching short-term and long-term investment opportunities.

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