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Even shortsighted short sellers are too powerful to ignore.
Joseph McCafferty, CFO Magazine
June 1, 2005
Like the day traders of the late 1990s, hedge funds are plaguing investor-relations (IR) departments. Notorious for short selling — and holding stocks for days or even hours, rather than years — most funds are not the type of buy-and-hold investors that companies relish. Hedge funds often swoop in and play the arbitrage after mergers are disclosed, sell shares after an earnings release, or move in and out of stocks on a daily basis to exploit slight discrepancies between share prices and convertible bonds. Such short-term trading can cause volatility and, worse, push share prices down.
For all these reasons, many companies fear communicating with the funds. But unlike pajama-clad day traders, hedge funds have massive amounts of capital at their disposal. While companies were advised to give day traders the cold shoulder in hopes that they would go away, today's experts warn that shunning fund managers is a bad idea.
Clearly, hedge funds aren't going away any time soon. In fact, more than 8,000 of them now hold nearly $1 trillion in assets, according to an estimate by the Hennessee Group LLC, a New York-based hedge-fund adviser. Catering largely to wealthy individuals and institutional investors, the funds represent one of the fastest-growing investment segments. An estimated $75 billion poured into them last year alone. Add the $64 billion in investment gains, and overall industry assets swelled by roughly 17 percent during 2004. But exact numbers are hard to come by in a hedge-fund world that's often shadowy and secretive. Unlike their mutual-fund cousins, hedge funds draw very little scrutiny, and few disclose much information about their holdings or investment strategies. Their secrecy, in fact, is yet another reason companies may be reluctant to talk to them.
Yet to some IR professionals, hedge funds present more opportunity than danger. "One trillion [dollars] in assets can't be ignored," says Louis Thompson, president and CEO of the National Investor Relations Institute, in Vienna, Virginia. He advises sorting through the funds and targeting those that may be a good fit with the shareholder base. And while he admits that some hedge funds have earned their reputation as fearsome short sellers, "they're not all bad," he insists. "Some are longer-term shareholders than many mutual funds." Randi Paikoff Feigin, IR vice president at Juniper Networks Inc., a Sunnyvale, California-based computer networking company, speaks with hedge-fund representatives regularly. "They have money," she says, "and they go long plenty of the time."
Indeed, at certain times and in certain industries, hedge funds are considered model investors. That's true these days in biotech and aerospace, for example, where funds are often seen as bringing unusual depth and intelligence to their research. "Their analysts are some of the best I talk to," says Paul Gifford, IR vice president at Goodrich Corp., a global aviation and defense supplier based in Charlotte, North Carolina. "We have many holders that are hedge funds, and since the aerospace cycle is improving, most are long." Pam Murphy, who heads IR and corporate communications at Wilmington, Delaware-based biotech firm Incyte Corp., says hedge-fund analysts are "important in the space because they tend to be very bright and educated on the science." Analysts at the hedge funds, which account for close to a third of Incyte's outstanding shares, "are often right out of med school."
Even when hedge funds aren't such ideal shareholders, many IR officers consider communicating with them to be a duty. Mark Aaron, IR vice president at Tiffany & Co. in New York, says he's inclined to converse with all holders that have an interest in the jewelry concern, even if their investment objectives aren't aligned with Tiffany's. "Hedge funds are here to stay, so companies better get used to talking to them," he says.
Others in IR suggest that it's because the funds often take aggressive positions that companies should communicate with them — seeing that link as the only chance at managing their actions, at least in a small way. While Aaron admits that dealing with hedge funds is "not always that pleasant when all they want to know is how the current quarter is going," he makes time for it anyway.
Such tolerance, though, is far from the norm. "Plenty of companies have closed off communication with hedge funds, especially if they have been burned by them in the past," says Stacey Ternowchek, executive vice president of analytic services for Thomson Financial's Corporate Group, which conducts investor targeting for companies. Some funds take short positions, then spread rumors to push stocks down, she explains. About half of Thomson's corporate clients have called in the past year or two looking for advice on dealing with funds. Her response: "The only way you can manage investors' behavior is to make sure they are making decisions in a fully informed fashion." In other words, speak up.
Often when companies do take phone calls from fund managers and analysts, or field their questions during conference calls, they still stop short of targeting them as investors. While Ternowchek says it's smart to keep lines of communication open, she doesn't believe that actively pursuing hedge funds is always a good idea. "They are incredibly difficult to deal with," she says, and not just because they trade over short cycles. "They have an insatiable thirst for information," she explains, and often have hidden motives. For example, it's not uncommon for hedge funds to feign interest in a company just to get more data on a competitor or the entire industry. Further, she says, "they are always pushing the envelope and seeking alternative methods of information gathering."
Some fund managers also try to pry out information that company officers are barred from revealing by Regulation Fair Disclosure, which prohibits the selective release of information. Orlando-based Darden Restaurants Inc., which owns and operates such chains as Red Lobster and Olive Garden, often gets calls from hedge-fund managers seeking early indicators as its monthly sales release approaches, for example. "You've got to be on your toes," says Matthew Stroud, Darden's vice president of IR. "Some are very persistent." Like most companies, Darden has a prerelease blackout period covering such investor conversations.
The blackouts don't always deter the hedge funds. "They're aggressive in terms of research," says Stroud. Fund analysts have been known to contact customers, suppliers, and lower-level employees in pursuit of a trading edge. Darden store managers sometimes get calls from individuals asking about restaurant sales trends, says Stroud. He suspects the callers are being paid by funds to gather store-based data. All Darden can do is stress that company policy prohibits release of the data outside proper channels, and violating the policy is grounds for dismissal.
Such fishing for information hasn't soured Stroud on hedge funds, though. "Most of them play by the rules," he says. A few have held Darden shares for more than two years, and some are on lists of funds that the company wants to target as shareholders.
IR executives who find hedge-fund managers sharp and knowledgeable about their industries suggest that other investors often are influenced by the trading activity of the funds — or at least what they can see of it. (A fund must file quarterly reports only if it has assets of more than $100 million.)
At Incyte, Pam Murphy believes that many problems associated with the short-term trading by hedge funds are offset by the liquidity this provides for other investors. She tries to promote a long-term vision of the company among hedge funds, and increasingly meets with those funds that come closest to fitting the company's investor profile. About 60 percent of all her investor meetings involve hedge funds, she says.
When companies do meet with the funds, the reason may reflect the funds' financial clout as much as their place in the investor profile. Hedge funds, which tend to be high-volume traders, create more commissions on Wall Street than traditional investors do. It's no surprise, then, that funds today are targeted more often to attend road shows and other events planned by investment banks. Thus, companies using those bankers to help raise capital may have no choice but to talk to hedge funds.
"Salespeople want to point you in the direction of hedge funds because they are the ones paying the bills," says Darden's Stroud, who adds that companies should also insist on seeing mutual funds that fit investor profiles. "If you lie down and roll over," he says, "you are just going to be visiting hedge funds all day."
While it is important to communicate with hedge funds, Thomson's Ternowchek suggests saving top management for traditional investors, and working with hedge funds at the IR level. To be sure, hedge funds will crave access to the CFO and CEO. "These people are very secretive about their own processes, yet they want the world to be an open book," she says. "It creates some tension."
Even if that drives an IR person crazy, the best way to cut the tension may be to take a page from Darden's book in dealing with hedge funds. Says Stroud, "We don't treat them any differently than we treat other investors."
Joseph McCafferty is news editor of CFO.