The Net Negative Effects Of Hedge Fund Activism In Pension Portfolios

Note: This article was originally published in the Summer 2020 NCPERS Newsletter

By Nell Geiser and Hudson Muñoz

The Communications Workers of America’s public sector members trust pension trustees and staff to manage assets to ensure their long-term retirement security. This trust is violated when pension funds entrust their capital to activist hedge funds. While these hedge funds claim to improve operating and financial performance at target companies, in practice they extract cash, destroy good jobs, and leave companies weaker in the long term. These tactics also harm pension participants, who are passive investors in much of the indexed stock market.

Our experience with hedge fund activism includes the September 2019 intervention by Elliott Management at AT&T, where we represent about 100,000 workers. We have learned that Elliott’s short-term agenda can harm its targets’ long-term performance and sustainability, partly from the job cuts Elliott tends to propose that divest firms of the human capital they need to compete.

When Elliott announced its $3.2 billion economic interest in AT&T and said the stock had potential to double in price, it also demanded general cost-cutting, greater outsourcing, divestitures, and massive stock buybacks to return cash to shareholders. Pension funds that invested in Elliott were indirectly buying into Elliott’s activism thesis that diverting capital to shareholders was better than having AT&T ramp up investment in strategic initiatives, such as fiber deployment and 5G expansion, which would generate organic growth through enhanced competition. This is the defining trade-off that activist hedge funds like Elliott Management force upon targeted companies: cash returns now versus organic growth and competition for the long term.

A recent study by Mark DesJardine and Rodolphe Durand found that hedge fund activism has a negative impact on long-term investors and stakeholders due to reductions in strategic investments. The study analyzed more than 1,300 activist hedge fund campaigns initiated from 2000 to 2016. The authors found that the number of employees at targeted companies decreased by 7.66% five years after the intervention and operating cash flow, a key indicator of profitability and long-term sustainability, decreased by more than 27% over the same period of time. The net effect of this was that the market value of targeted firms decreased by 9.71%, targeted companies were left with an average cash deficit of $61 million five years after the activist intervention began, and corporate social responsibility indicators suffered.

These statistical findings mirror our experience at AT&T. Our analysis of Elliott’s plan estimated that it would put 30,000 jobs at risk of elimination or wage reduction. AT&T has largely bent to Elliott’s demands, and in June disclosed plans to lay-off more than 3,000 workers. This critical infrastructure giant has also reduced capital expenditures and ramped up share buybacks (prior to a pandemic-induced pause), as dictated by Elliott’s playbook.

Pension investment decision-makers should be concerned about the net negative long-term effects of hedge fund activism at targeted companies in its own right. They should also think about hedge fund activism in terms of its knock-on effects. Since hedge fund activism tends to bring down the market value and performance of targeted companies, it will also drag down the value of passive investments in the equity and fixed income securities the pension fund also holds in the same companies during and after the activist engagement. Public fund CIOs and trustees should select asset classes and individual investments with expected returns that align with the investment horizons of plan participants. As recent outflows from the hedge fund asset class suggest, the time is now for a reexamination of hedge fund investments that rely on activist tactics for short-term cash extraction while ignoring the long-term consequences for both communities and passively held equity value.

BIOGRAPHY

Nell Geiser is Director of Research at the Communications Workers of America and a CFA Institute charter holder. CWA represents public sector workers in state and local government across the country, along with workers in telecommunications, airlines, manufacturing and other sectors.

Hudson Muñoz is a Senior Strategic Research Associate at the Communications Workers of America where he works to educate the public about the social and investment impacts of hedge fund activism. He graduated magna cum laude from the Johns Hopkins University Carey School of Business and Krieger School of Arts and Sciences dual Master of Business Administration and Master of Arts in Government program in August 2019.