If you’re a part-owner of a business and the value of your business is falling, what would you do? Would you do nothing, believing the directors and management have things under control? What would it take before you felt like taking matters into your own hands?
Unfortunately, a lot of individual shareholders do nothing. Many don’t even look at proxy statements or vote for directors. According to Jason Zweig, on average between a third and a half of all individual investors don’t vote their proxies. A simple vote should be a basic shareholder responsibility. The company and other shareholders benefit by having all shareholders acting with the best interests of the company in mind. I think it’s been true since the time of Graham that most investors put most of their effort into buying a stock, a little into selling it, but none into owning it.
With these thoughts in mind, there are some guys out there who put a whole bunch of effort into owning stocks. These are the activist investors, often guys who run hedge funds. The most interesting guy I’ve currently been reading about is Phil Goldstein who runs Bulldog Investors (see the recent Fortune article, dated June 18, 2008).
Phil used to be a civil engineer for New York, but got bored with it and nearly became a professional gambler, but instead focused his attention on investing in closed-end funds. The neat thing about closed end funds is the fact that they seem to be more prone to market ineffeciences.
Like traditional mutual funds, closed-end funds invest in stocks and bonds, typically with some sector or strategic focus. Shares are bought and sold on major exchanges, where they can trade for more or less than a fund’s net asset value, or NAV, which is defined as the current market price of all the investments it holds. In other words, the stock price can be higher or lower than the per share value of the fund’s investments.
The way Goldstein makes money is by investing in closed-end funds that are trading at a deep discount to its NAV and then using his large stake to pressure management to make changes that will close percentage gap between the share price and the NAV. Pressuring management usually means asking nicely first, and then progressing to proxy fights or litigation. The most common methods for closing the gap is either opening up the fund or liquidating the fund.
Though it might be easy to spot the inefficienies (just look here – easy as pie!), it seems to be a lot harder to eliminate the efficiencies. Challenging difficult and intransigent management via proxy fights and legal battles could very well end up being Pyrrhic victories. However, in the end, I think people like Phil Goldstein and Carl Icahn (check out his new blog) are the embodiment of the ultimate shareholder as their actions have in the end benefited both their “targets” and their co-shareholders by eliminating inefficiencies and by increasing shareholder value.
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