Growth Companies

As Hedge Funds Meddle, Corporate Bond Risk Rises

Activist hedge funds agitating for shareholder-friendly actions by companies are increasing the chances of "credit-negative" events, says Moody's.
Vincent RyanMarch 11, 2014

As activist hedge funds target more public companies and their boards, they are chipping away at the creditworthiness of U.S. companies, increasing the risk of owning corporate bonds. So says Moody’s in a research report released this week. 

A rising tide of credit-negative events could hit corporate issuers in 2014, according to a story in the Financial Times. Activist investors tend to push for shareholder friendly moves like buybacks and dividend increases. But if companies reach into their admittedly vast cash reserves to pay shareholders, that leaves them less money to pay back debt and gives them a smaller margin of safety against earnings disruptions. And if they issue bonds to pay for shareholder distributions, they increase their leverage.

Management is finding it hard to ignore activist demands as institutional investors back the activists, which is beginning to shift the balance of power away from creditors.

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Technology sector companies in particular are vulnerable to activist-influenced actions that will damage their credit quality, says Moody’s. Many have large amounts of cash on their balance sheets and few of them issue large dividends. In 2013, ADT, BMC Software, and Nuance Communications all suffered downgrades due, in part, to their caving into the demands of activist hedge funds.

Moody’s said there were 220 activist campaigns in North America in 2013, up 209 in 2012. Meanwhile assets managed by activist hedge funds rose to $93 billion last year, from $65.5 billion in 2012, according to research data cited by Moody’s.

Source: Activist hedge funds increase corporate bond risk, says Moody’s