Tactics Used by Listed Investment Companies to Defend Against Activists

In this article published in the February edition of Equity for the Australian Shareholders’ Association, David Alder discusses tactics used by Listed Investment Companies to defend against shareholder activism.

Whilst shareholder activism is entrenched in the US and parts of Europe, it is considered to be in its infancy in Australia. An activist investor is someone that acquires a holding of shares in a company they consider to be undervalued with the objective of creating shareholder value through agitating for change for the benefit of all shareholders. A company can become an activist’s target if its corporate strategy, governance practices, financial performance, approach to capital management, or a combination of these, is considered to be lacking.

Listed Investment Companies (LICs) are increasingly popular investment vehicles, if the number of them being listed on the Australian Securities Exchange is anything to go by – over 30 have listed since 2012 taking the total number to more than 85 and funds under management in excess of $30 billion.

LIC board and investment managers are commonly using strategies and tactics to protect their ‘rivers of gold’, also known as management and performance fees, so it is important shareholders understand their rights to hold them to account for issues such as investment performance and management fees.

A common strategy utilised by many underperforming LICs is to buy back their own shares. Many LICs trade at a significant discount to their net tangible assets (NTA) and boards may initiate a share buy-back program with the aim to narrow this discount. This can often have the effect of artificially increasing the demand for the company’s shares and therefore temporarily bolstering the share price.

While this tactic is typically used to place a ‘floor’ under the share price there is no evidence to suggest that share buy-backs improve an LIC’s share price relative to NTA over the longer term in the absence of other initiatives which may enhance shareholder value.

Hunter Hall Global Value’s (HHV) recent use of this tactic is interesting. On the same day that the co-founder and Chief Investment Officer Peter Hall announced he had sold part of his shareholding in the company’s manager, Hunter Hall International (HHL), an on-market buy back was announced to support the share price of HHV. Clearly this was designed to reduce pressure from activist investors on the register who have been campaigning the company’s board for several years to take actions to close the discount to NTA. Questions around corporate governance had been an issue and have now been heightened given the arrangements around Hall’s exit, including the price the buyer (Washington H. Soul Pattinson and Co. Limited) has paid for his stake in HHL (they currently own 19.9% but have an option to go to 44% via a takeover offer which is now in motion).

Another strategy which potentially raises conflict of interest issues (and may occur amongst larger wealth management groups) occurs when related parties to the Investment Manager buys shares in the LIC under the guise of supporting their shareholders.

Whilst this can push up the share price in the short term it could also be considered a defence mechanism used to make it more difficult to be subject to a hostile move to terminate the Investment Manager or wind up the company to return capital to shareholders.

In a recent high profile case, AMP Capital China Growth Fund (AGF) was forced to wind up its portfolio of Chinese listed shares following an Extraordinary General Meeting (EGM) called by a handful of fund manager shareholders.  The New South Wales Supreme Court excluded AMP Life (AGF’s largest shareholder with a 32% stake) from voting on the windup resolution put forward by the group of activist shareholders which ultimately lead to its demise.

In the case of HHV don’t be surprised to see Washington H. Soul Pattinson and Co. attempt to buy out Wilson Asset Management’s 12% shareholding as a means of trying to head off a possible windup of the vehicle. It will be interesting to see if a court prevents Washington from voting these shares as they do not presently have a controlling stake in HHL (unlike in the AMP case).

As retail superannuation master trusts and industry superannuation fund improve their product offerings to accommodate direct share investment (including LICs) one small quirk to be aware of is the role of the trustee. Superannuation fund trustees are becoming increasingly conscious of their members’ views on company conduct, performance and board remuneration.  This is not an issue for self managed superannuation funds where the member is the trustee, however it is surely only a matter of time before members of the very large industry and retail superannuation funds take steps to demand their say in how votes are directed.

Last year, Commonwealth Bank of Australia’s shareholders, led by several large industry super funds, rejected the remuneration report tabled at the 2016 AGM resulting in it becoming the first Australian bank to receive a ‘first strike’ under laws enacted in 2011 to improve the accountability of company boards.

Shareholders should not underestimate the lengths boards will go in order to defend their positions and the politics that are involved. As it becomes apparent that their position may be at threat often the LIC board will resort to engaging in open warfare via engaging expensive legal, public relations and proxy solicitation firms (all at shareholder expense) to garner votes. Whilst both sides can do the same it can result in ‘open letters’ stating their case, distributed via the media and/or Australian Securities Exchange.