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Asset Allocation

Study: Institutional Trash is Hedge Fund Treasure

A new study of trading data related to major 'activist' hedge fund acquisitions indicates that institutional investors are usually on the other side of the deal.

(September 4, 2012) – Hedge funds are buying what institutional investors are selling, according to new research into major public equity trades.

A recent whitepaper asserts that when a hedge fund picks up more than 5% ownership in a certain stock, it’s usually because a pension or mutual fund has unloaded its holdings. Nickolay Gantchev and Pab Jotikasthira, both finance professors at the University of North Carolina in Chapel Hill, analyzed scores of trading data from major hedge fund acquisitions and high frequency trades by non-hedge fund institutions. 

‘Activist’ campaigns by hedge funds—targeting and quickly buying significant ownership in certain companies, with the intention of influencing operations—have been steadily on the rise. In the last decade, hedge funds have launched more than 300 such attacks on major companies, according to research out of Harvard. And the majority of the time, institutional investors facilitate these purchases, Gantchev and Jotikasthira found. 

“At the daily frequency, we find a strong positive relationship between the net selling of pension and mutual funds and the hedge fund’s purchase of target shares,” the authors write. “Examining their trading in other (non-activist) stocks, we find that a significantly larger fraction of these [institutional] funds’ trading constitutes selling suggesting that they are relatively more ‘distressed’ and trade for liquidity reasons…We find that institutional selling lowers prices and increases turnover, creating a favorable market environment for the activist to acquire a large quantity of target shares.” 

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If pension funds and mutual funds are usually the sellers of these powerful pools of shares, they’re also often the buyers, albeit indirectly. Institutional investment in activist hedge funds has jumped in the last two years, as asset owners seek out robust, uncorrelated equity returns. In January, for instance, New Jersey’s public pension system sunk $150 million into Cevian Capital II. In a letter proposing the allocation, Director Timothy Walsh described Cevian’s investment style as “hands-on and constructive.” The hedge fund “conducts intensive research and creates action plan to enhance the value of the company before making investment or engaging in a dialogue with the management. [Cevian] improves governance, operations and frequently joins the board of directors to affect change,” Walsh wrote. The fund has returned an annualized 11.46% since its inception in 2006. 

Likewise, two major activist funds, ValueAct Capital Management LP and Starboard Value LP, recently announced they have sealed off investment in their activist strategies, capped at $8 billion and $1 billion, respectively.

Read all of Gantchev and Jotikasthira’s paper here.

Home > News > Regulation > Bain, Apollo, KKR Under Investigation for Tax Dodging
Regulation

Bain, Apollo, KKR Under Investigation for Tax Dodging

New York's attorney general has subpoenaed major private equity firms, suspecting they convert management fees into investments to duck income taxes, according to the New York Times.

(September 4, 2012) – The New York attorney general is investigating a number of leading private equity firms—including Bain Capital and Apollo Global Management—on suspicion of tax evasion, according to the New York Times. 

Eric Schneiderman, the attorney general, is looking into whether the firms converted certain management fees into fund investments, thereby qualifying the fees to be taxed at the much lower capital gains rate. In recent weeks, Schneiderman has subpoenaed more than a dozen private equity companies, including Kohlberg Kravis Roberts & Company, Sun Capital Partners, TPG Capital, and Silver Lake Partners, as well as Bain and Apollo. 

The tax strategy under investigation came to light publicly last month when Gawker published a 950-page cache of Bain’s internal financial documents. The papers show a total of least $1 billion in fees converted into investments, which then fall under the 15% capital gains tax bracket. Such a move would short the government more than $220 million in federal income and Medicare taxes. 

Mitt Romney, Bain’s founder and the Republican presidential nominee, continues to receive income from the private equity firm. His personal financial lawyer, R. Bradform Malt, issued a statement saying Romney never benefitted from the practice. 

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“Investing fee income is a common, accepted and totally legal practice,” he said. (Other tax experts disagree; the practice’s legal status is debated and ambiguous. Blackstone and the Carlyle Group, for instance, have both made points in regulatory filings that they do not engage in fee-to-investment conversion.) “However, Governor Romney’s retirement agreement did not give the blind trust or him the right to do this, and I can confirm that neither he nor the trust has ever done this, whether before or after he retired from Bain Capital.” 

The attorney general’s office did not respond to aiCIO for immediate comment, nor has it officially confirmed or denied the investigation. Schneiderman did release a statement on Labor Day—two days after the New York Times published its report. 

“On this Labor Day, we should look to the labor movement’s legacy of lifting up all Americans to fulfill the promise of shared prosperity…That means vigorously enforcing our state’s labor laws using civil and criminal tools so that no unscrupulous employer will get an unfair advantage over law-abiding businesspeople by unlawfully cutting corners…We must continue to uphold New York’s proud tradition of standing up for working people, and protecting those who are struggling in these tough economic times.”

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