Abstract

This research provides a unique analysis of private engagements by an activist fund, the Hermes U.K. Focus Fund (HUKFF). Unlike previous studies relying on public information, this report utilises internal data from Hermes, the fund manager owned by the British Telecom Pension Scheme. The study finds that the fund predominantly executes shareholder activism through private interventions, which are often unobservable to the public. These engagements are found to be the primary driver of the fund’s substantial outperformance of market benchmarks. The analysis categorises engagements and measures their impact on returns, finding that Hermes frequently achieves significant strategic changes, such as refocusing core businesses and replacing executive management, including CEOs and chairmen.

Description of the legal environment, the fund, and the dataset

The U.K. provides a more favourable institutional setting for shareholder activism compared to the U.S. due to several legal tools. Under U.K. law, shareholders can initiate changes to a company’s articles of association and memorandum by vote. Furthermore, shareholders commanding at least 10% of the paid-up voting capital can requisition an Extraordinary General Meeting (EGM) to remove directors at any time. This legal framework grants activist investors “real authority” over target boards. The dataset for this study is comprehensive, including letters, memos, minutes, and recordings of telephone conversations from the fund’s inception in 1998 through 2004.

The Hermes U.K. Focus Fund and its activism approach

The HUKFF was established as a response to free-riding problems in institutional activism. It targets underperforming companies where Hermes already holds a stake through its index tracker fund, allowing it to partially internalise the benefits of its activism. The fund applies a triple investment criterion: the company must be underperforming, the fund must believe it can successfully engage the company, and there must be an expectation of obtaining at least 20% more value over the current share price. Once invested, the fund begins a private engagement process, which can turn confrontational if management rejects proposed changes.

Types and frequency of engagement activities

Engagement by the HUKFF is characterised by its private nature. In all 30 cases studied, the fund held numerous meetings with CEOs, chairmen, and CFOs, averaging 9.73 meetings per company. The fund also engaged with other executives and non-executive directors. Strikingly, these engagements rarely took a public form; the fund only posed a question at an annual general meeting in one case and solicited votes against management in two cases. This private approach is supported by the implicit threat of requisitioning an EGM, which acts as a powerful lever for change.

Engagement objectives and outcomes

The fund’s primary objectives involve substantial restructuring and board changes. In 28 out of 30 cases, the HUKFF aimed for operational restructuring, such as selling non-core divisions to improve focus. It sought to replace the CEO in 14.5 cases and the chairman in 18.5 cases, achieving these outcomes in over 80% and 75% of instances, respectively. Additionally, the fund frequently sought increased cash payouts to shareholders, an objective achieved in 11 cases. These figures for management turnover are significantly higher than those observed in poorly performing companies without such activist intervention.

Event study on outcomes and operating performance

The research measures the impact of these outcomes through an event study. When confounding information is excluded, mean abnormal returns are 5.30% within a seven-day window around the announcement of a change. The largest returns are associated with restructuring activities (6.6%) and changes in CEOs or chairmen (6.0%). Post-intervention analysis shows that the size of assets and employee numbers are substantially lower, while the return on assets (ROA) is higher two years after the fund’s exit. The mean ROA rose from 6.8% one year prior to engagement to 8.3% two years after completion.

Performance of HUKFF and the gains to activism

The HUKFF generated an annual raw return net of fees of 8.2% and an abnormal return of 4.9% against the FTSE All-Share Index over the 1998-2004 period. The study estimates that 92% of the fund’s sterling excess return is attributable to activist outcomes. Hostility in engagements is linked to higher gains; mixed engagements contributed 55.1% of the sterling return, while confrontational engagements contributed 30.5%. The findings suggest that the fund does not trade on private information but rather generates value through the successful execution of its stated governance objectives.