“Perseverance is not a long race; it is many short races one after the other.”*

*Walter Elliot

Two of the key tenets of institutional investment today are sustainability and long-term horizons.  Institutional asset owners require their active asset manager to identify companies that can generate a solid rate of return on investment and to do so consistently over a long-time horizon, say 5 plus years. Increasingly the added emphasis has been on those companies that can do this in a way that manages production resources in a sustainable way.  This now translates to an expectation on asset managers to incorporate ESG criteria into their process for selecting companies in which they invest.  Correspondingly, companies have examined their working practices and assessed where they fail, often implementing practices to address these shortcomings and the actions taken and their broad philosophy towards sustainability are typically articulated in their corporate social responsibility (CSR) policy. 

Given this backdrop I was surprised to read a paper which suggests that activist hedge funds focus on those companies that promote sustainable practices and specifically use their CSR and announcements around it as a signal to identify potential targets.[i]   The surprise here is that it is those companies that are seeking sustainability that are targeted. 

A key driver to this is time horizon.  The authors argue that hedge funds are typically taking a shorter-term view and ‘..regard as “wasteful” intentions and capabilities that prevent firms from maximising shareholder value in the short term.’[ii]  ‘Wasteful’ intentions would be a firm’s intention to act with a long-term vision and to take into account the interests of different stakeholders.  As example of time horizon, in one study 47% of US based activist hedge funds held onto a stock for less than 6 months; 84% less than 2 years.[iii]

The research examined the use of CSR as a way to ‘signal’ intentions, with the researchers identifying three types of costs associated with the activity:  ‘production costs’ – the cost of actually doing something to improve sustainability or CSR, e.g. cost of signing up to an industry standard; ‘penalty costs’ – where stakeholders see through an action as being false or spin, e.g. greenwashing; and ‘reaction costs’ – where the CSR is being used by unintended audience, e.g. hedge funds, for  purposes not intended.

The research found that if you are a company with a strong CSR in an industry with, on average, a poor CSR, you are more likely to be targeted by an activist.  So once targeted, what is the extent of these ‘reaction costs’?  On average it costs ‘$12.5 million per proxy contest for large capitalisation firms’[iv] and the impact on management can be significant, as the research quotes of one company:  “We were all so burnt out.  Our CEO looked like he had gone through a war…It took another six months for our leadership team to recover and get the eye back on the ball of managing the company.”

The moral of the story?  Rather depressingly it would seem that even with the best of intentions and a strategy that might positively reflect a move to improved sustainability, there are going to be some entities out there that are after a quick buck!

[i] Why activist hedge funds target socially responsible firms: the reaction costs of signally corporate social responsibility, Mark R. DeJardine, Emilio Marti, Rodophe Durand, Academy of Management Journal 2020, Vol. 64, No.3, 851-872.

[ii] Ibid, 852

[iii] Ibid 854 (Zenner et al., 2015)

[iv] Ibid 856 (Activist Insight, 2017:7)

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