Saturday, May 21, 2005

Hedge-fund activism sparking concerns

By Rachel Beck / AP Business Writer

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NEW YORK -- The trading strategies of hedge funds this year aren't just about betting on moves in commodities or shorting stocks. How about taking on CEOs right in the public view?

Just ask MCI Inc. and Blockbuster Inc. what this is all about. They've recently felt the wrath of hedge funds aggressively trying to influence corporate managers to do as they see fit.

And the hedge funds are having an effect. The trouble is, what's good for hedge funds might not be good for the company or its other shareholders, too.

Hedge funds -- which are barely regulated investment funds generally made up of money from wealthy individuals and institutions -- have been corporate activists before. But they are taking on a more pronounced role in corporate dealings this year, publicly meddling in everything from merger decisions to executive compensation.

That largely has to do with the flow of money pouring into hedge funds in recent years, which has given many fund managers the opportunity to take larger positions in big-name companies than they did in the past, according to Robert G. Leonard, a group leader in the hedge-fund practice at the law firm Bryan Cave.

In 1990, there were 610 hedge funds with about $39 billion in assets. Today, that has grown to nearly 8,000 funds with a total asset base topping $1 trillion, thanks to rising investments from individuals and pension funds, according to the Chicago-based research firm Hedge Fund Research Inc.

At the same time, hedge funds are also struggling to match their stellar performance of the recent past. Some of their frequently used trading tactics, such as arbitrage, shorting stocks and betting on commodities futures movement, haven't succeeded much this year.

Standard & Poor's Hedge Fund Index, which tracks a broad range of trading strategies, is down 1.51 percent from the start of the year, suggesting that many of the funds made some bad bets. Contrast that with the gain in the index of 16.72 percent seen over the last three years and 40.73 percent in the last five years.

"Hedge funds have clearly started thinking outside of the usual box," said B. Espen Eckbo, the founding director of the Center for Corporate Governance at the Tuck School of Business at Dartmouth College. "They see that you can do something to change the shareholder value by picking on the governance side of a company."

Just look at what has gone on at the movie-rental chain Blockbuster. After amassing a 9.7 percent stake in the company, billionaire financier Carl Icahn, with the backing of powerful hedge funds, managed to win himself and two allies seats on Blockbuster's board. And in that same vote at the company's annual meeting on May 11, Blockbuster chairman John Antioco was defeated for re-election, though the board has since moved to reappoint him.

At MCI, hedge funds have been fighting for months for the telecommunications company to take a higher buyout offer from Qwest Communications Inc., which offered $9.85 billion, or $30 a share, compared with Verizon Communications Inc.'s $8.54 billion, or $26 a share, bid.

And while MCI has accepted the lower Verizon bid because the board felt it was a more stable and financially secure partner for the long-term, that hasn't stopped the hedge funds from making their case heard.

This week, a hedge-fund led investor contingent representing about 28 percent of MCI shareholders withheld their votes to re-elect the MCI board. That no-confidence vote from a solid MCI shareholder base is raising some suspicion Qwest may re-enter the fray.

Even Germany's Frankfurt stock exchange has come under attack from hedge funds. They are accused of being partly behind the ouster of the Deutsche Boerse AG's CEO earlier this month because he had tried to steer the exchange into acquiring the London Stock Exchange.

Now, the German government is considering tougher controls on hedge funds, and the country's financial regulator has said it may investigate whether major shareholders violated German securities law by conspiring to force out the exchange's CEO.

With hedge funds taking on this more activist role, it's reasonable to question their intentions when their ultimate goal is to tally big profits. Are they looking out for companies' long-term success to lift share values or is the maneuvering just to get a quick rise so they can lock in gains and bail out?

In the case of Icahn, he now has a three-year term on the Blockbuster board, so maybe his money will be parked for the duration, but there is no guaranteeing his hedge-fund partners will stick around. And at MCI, the hedge-fund investors may be clamoring for the higher Qwest bid because they want to take their money and run.

It will take time to see what the hedge funds really want. When the dust settles, maybe then it will be obvious whether they helped or hurt the companies that they invested in.

Rachel Beck is the national business columnist for The Associated Press. Write to her at rbeck@ap.org