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Apr 30, 1999

All eyes on value

Activist funds around the world are combining their clout to invest more power over companies

Poorly-performing companies take heed: the world's biggest shareholders – institutional investors – are increasingly talking among themselves, comparing notes and networking to orchestrate a united, activist front in the fight for shareholder value.

Moreover, with roots in the US, the vine of shareholder activism has taken hold in the UK and seems destined to spread to continental Europe and beyond. Yet while Anglo/US investors are often the most vigorous force for change, 'in-country' shareholders are learning to take up the activist mantle, too.

'In virtually all European markets, privatization and the growth of local pension funds are inevitably leading to activism,' says Stanley Dubiel, director of global research at Institutional Shareholder Services. 'European fund managers see the success of their US counterparts and want to join the party.'

Altogether, a radical power shift is happening around the investment world. US management guru Peter Drucker calls it the 'middle class revolution'. Like many of history's most significant revolutions, few know it is happening until the new regime is firmly in place. Yet happening it is, and if capitalist companies are going to follow the money, they must play by new rules.

For now, however, those rules are being made mostly by US pension funds. With an investment portfolio topping $150 bn, Calpers is America's largest public pension fund.

Bill Crist, an economist and president of Calpers' board of administration, says a slow but steady sea-change is occurring around the world in how corporations are managed and governed. 'We have been pressing for it for more than a decade and will probably keep doing so for the next 40 years,' says Crist. 'But it is now beyond an exercise of just Calpers and a few others. These are now truly international movements.'

Transatlantic allies

As America's best-known standard bearer of institutional activism, Calpers has taken its activism abroad for some time, but now it is ratcheting up the pressure, linking directly with local partners.

One such partner is the UK's Active Value Advisors, in which Calpers has made a $200 mn investment. An approach focused on corporate restructuring has brought Active Value Advisors success in the UK corporate governance arena. Now, having just closed a new $800 mn fund, it is poised for its first major assault on continental Europe.

There, according to Julian Treger, director at Active Value Advisors, the main obstacle is a lack of shareholder democracy. Treger believes the Continent's penchant for cross-shareholdings and dual-class shares must be restrained if the region's companies are to attract foreign capital and develop a more thriving public market.

Still, he also sees signs of change. 'A few years ago, [European managements] looked at us like we were from Mars,' says Treger. 'Now, they are accepting the inevitable fact that shareholders own the company and management works for them.'

Another UK-based Calpers ally is Hermes, a £32.2 bn pension fund manager which grew out of an institution originally set up to manage the Post Office pension fund. Today it still runs this fund, as well as the now separate British Telecom scheme. It is one of the UK's largest pension funds. Combined, the Calpers and Hermes clout is considerable. In total, they manage some $62 bn of investments in US-based companies and $36 bn in UK firms.

Last November, Hermes and Calpers entered what they call a 'global corporate governance alliance'. Not involving any exchange of money, the deal is primarily an exchange of resources.

'The alliance accepts Calpers has the greater knowledge in the US and we have the greater knowledge here,' says Peter Butler, Hermes corporate focus director and chief executive of Hermes Lens Asset Management Ltd. 'It lets us both vote more intelligently in each other's market. In time, we want to set up similar relationships with other activist pension funds around the world.'

While Hermes allies with Calpers on one activist front, it has also brought some other big US guns directly into its fold. Last year, Hermes Pensions Management and US-based activist Lens Investment Management announced a joint venture to create Hermes Lens Asset Management (HLAM). The first fund managed by HLAM is the Hermes UK Focus Fund, intended for investment by institutional investors.

Events moved smoothly and, late last year, Lens and HLAM announced a full merger to form a new international asset management structure specializing in shareholder activism. The merger marks another step toward an international portfolio of activist funds.

Learning to be activist

The Hermes/Lens link is a harbinger of global activism's future. To understand how it developed, one must go back to 1995. That year, Hermes CEO Alastair Ross Goobey headed a dramatically productive campaign to reduce the notice period in executive contracts. Flush with success, Ross Goobey reinforced Hermes' traditionally strong approach to corporate governance with the decision to hire someone to handle ownership issues exclusively. He did not want a fund manager or a consultant. He wanted someone who had been through the mill as a board director. That person was Peter Butler.

Butler had been finance director at British Sugar when its parent, Berisford, got into trouble in 1990. Butler became a Berisford director and spent the next three years repaying some £1.4 bn of bank debt while trying to salvage some shareholder value at the end.

At first, Butler concentrated on the existing Hermes portfolio. He had several successes and one or two failures as he learned the ropes. Clearly, good governance was critical when owning so many companies. Still, overhead was not unlimited. Ross Goobey told Butler to turn his corporate governance activities into a clearly-defined profit center.

So off went Butler to visit activist fund managers in the US including Bob Monks, a governance pioneer who is now chief of Portland, Maine-based Lens (see opposite page). Each was smitten by the other's ideas and they talked solidly for two days. Butler returned with the idea of the UK Focus Fund, an activist fund manager that would invest in undervalued mid and large cap companies.

The UK Focus Fund is unprecedented. First, a pension fund controls it. 'That sends a strong message to boards that Hermes is in it for a long-term solution,' says Butler. Secondly, Hermes UK Focus Fund has leverage. Before it buys a single share, it already has, under the Hermes umbrella, 1.25 percent of every company it could invest in.

'In some activist endeavors, we could be successful with just 1.25 percent,' comments Butler. 'But it is actually much easier with a higher percentage. As a small shareholder, everyone is polite. When you are among the top five, both the board and other shareholders take you far more seriously.'

One company that took Hermes UK Focus Fund seriously was the Mirror Group newspaper chain. Earlier this year, Hermes played a major role in turfing out its chief executive, who the fund believed had been hindering share price growth after making several questionable strategic initiatives. 'We empowered a non-executive chairman and directors to make change,' says Butler. 'Some shareholders wanted to merge or sell the company. Sometimes, corporate restructuring is appropriate, but we have a general preference for helping boards resolve their own problems.'

Change agent

On the Continent, activists are also taking advantage of the even more prevalent existence of non-executive boards. 'There are some aspects of European corporate governance that are really quite good for shareholders,' says Jan Akesson, director in charge of new investments at Swedish investment company AB Custos. Akesson points out that except for the CEO, Swedish boards are composed entirely of non-executive directors. 'That can sometimes help in putting shareholders' views on the agenda,' says Akesson. It is a distinction between roles which he judges to be superior to the system in the UK.

Until 1995, Custos was entangled in cross-shareholdings, which in its case included a link with Volvo. That year, after mounting criticism, the ties were broken and by early 1997 the board and management had been changed and a new, activist strategy put in place.

As a listed company with some $1 bn in market capitalization, Custos understands what market discipline is all about. Its investors include Swedish pension funds and US-based Franklin Mutual Advisors. 'In some ways, we are a tool for other investors,' says Akesson. 'We have institutional investors who are increasingly aware of the impact of corporate governance but may not have the ambition needed to put themselves on the board or to drive change themselves.'

Custos invests in one or two underperforming companies a year with a 'meaningful' ownership stake – typically 10-30 percent. 'It is not a majority stake, but enough to be influential,' says Akesson. 'We also ensure we have at least two representatives on the board. That lets us contribute to value creation in these companies that we invest in.'

While many Anglo/American style activists may fume over Europe's dual-class share structures, Custos exploits them. One of its first and largest investments was in ASG, a Nordic transportation company with much of its assets tied up in real estate across Europe. 'Margins in the transportation business are razor thin,' says Akesson. 'You cannot tie up capital if you want to make money.' Custos bought out the voting shares of the trucking association that owned them, effectively giving it ten votes for the price of one. Soon after, the board and CEO were replaced.

Striking a balance

However, working in Scandinavia's relatively small business community means striking a balance between being sufficiently aggressive and staying friendly with managements and other shareholders not yet used to Custos' activist tactics. Still, with ASG, return to shareholders has been 80 percent over the last 18 months. That tends to make it relatively easy to make friends and influence people.

But around the globe now, where companies underperform market expectations or where their governance systems fail to match international standards, the lessons are clear. Activist investors are growing ever more sophisticated, and their moves toward collective clout to form more focused power groups are plain to see. Corporate managements would be advised not to look away for too long.