Should regulators discourage or encourage shareholder activism? It is pretty much undisputable that activism generally leads to outperformance during the 13D holding period. There are tons of academic and empirical studies, as well as our data at 13D Monitor, to support that notion. That is why activism is such a popular strategy. There are even studies that say that activism continues to add value for years after the activist exits its position. But activist opponents anecdotally claim that activists are short-term investors and activism leads to short-term gains at the expense of long-term investors. Let’s analyze that allegation.
In the 900 activist 13D filings 13D Monitor reported on since April 1, 2006, the average 13D holding period has been 2.01 years. That is just the period between the activist exceeding 5 percent and exiting its 13D by going below 5 percent, converting to a 13G or otherwise. It does not include the holding period of the activist before it went above 5 percent or after it exited its 13D but still held its position. And it includes 13Ds filed within the last several months where the holding period is short because the activist just acquired its position. So, the average activist holding period is significantly above two years.
On the other hand, according to William Harding, an analyst with Morningstar, the average turnover ratio for managed domestic stock funds is 130 percent, implying less than a 1 year holding period. Bill Barker of Motley Fool says “Managed mutual funds have an average turnover rate of approximately 85 percent, meaning that funds are turning over nearly all of their holdings every year.” And Kiplinger says: “The typical stock mutual fund has a turnover rate of 100 percent -- which means that, on average, it holds stocks for about a year.” So why is it that large mutual funds are considered long term investors with holding periods of 4+ years?
The reason is that mutual fund complexes like Fidelity, Blackrock, Vanguard, etc. consist of hundreds of different portfolio managers, each making independent buy and sell decisions. Their 13F, 13G and 13D filings aggregate the holdings of all of these portfolio managers giving the appearance that they are holding a stock for many years but actually this is many short-, medium- and long-term portfolio managers buying and selling the stock of the same company. So, the portfolio managers that hold IBM in 2013 may be totally different from the portfolio managers that hold the stock in 2018, but the overall mutual fund complex would still be reporting continuous ownership of the stock during the five year period. Factor in index funds, which have to hold certain stocks without making any investment decision, and this dynamic is magnified. This is not to say that there are not some long-term shareholders that hold positions for 5+ years and there are not some investors, including activists, who are very short-term minded. But to generalize activists as “short termers” and mutual funds as long=term investors is a complete distortion of the truth, and their time horizons are likely more similar than people think.
If there really were the large chasm between activists and mutual funds with respect to their investment horizons that activist opponents would lead you to believe, how is it that activists are getting an increasing level of support from mutual funds? The truth is that this long-term/short-term distinction is significantly overblown and not an issue for institutional investors. Yes, there are some activist agendas that are short-term minded that could hurt the long-term prospects of the company. But institutional investors understand that a short-term fix to a company could have a long-term benefit. After an activist agenda is implemented, it does not matter if the activist continues to hold the stock for a day or a decade if the company was put on a better long-term trajectory. Moreover, these activist agendas cannot get implemented without the majority support of the other shareholders, most of whom are large institutional investors. These sophisticated investors analyze the proposals of activists and management and make a case-by-case decision, refusing to support the activist if they believe its agenda is not consistent with their investment horizon. These institutional investors do not need to be protected from activists. Most of them would much rather operate in a market where activism exists.
Ken Squire founded 13D Monitor, a research provider specializing in 13D filings and shareholder activism, in 2006, and in 2012, he founded The 13D Activist Fund, an event-driven mutual fund that focuses on 13D filings. He is also the author of a weekly column in Barron’s entitled “Activist Spotlight.”