Combating the ineptitude and excesses of poorly-managed company boards as the financial crisis progresses ensures that activist hedge funds are facing what could be their busiest year in the past decade. Here are 10 reasons why, originally put forward in Seeking Alpha.

1. Democrats are in the White House. In the Democrat tradition, the US Securities and Exchange Commission (SEC) should be more supportive of shareholder activists. Republican SEC boards usually support pro-management and Business Roundtable policies. Although the Business Roundtable has empowered certain investors, such as the big Teamsters’ Union pension fund, by enabling them to nominate alternative board members, but not extending this right to vanilla retail or institutional shareholders. But the Obama administration aims to strengthen shareholder rights to promote better governance and investment returns over time.

2. Bigger board battles. The US president will probably appoint an SEC chair that will assert openness, fairness and rights for all shareholders. Specifically, the “proxy access” initiative is expected to return in some form, enabling shareholders to put forward rival board candidates without having to fund a proxy contest against the candidates nominated by the company (which draws on capital supplied by shareholders to present its candidates).

3. Valuations have cascaded. Activist strategies are usually combined with a buy-and-hold approach to an undervalued stock. As value investors, they were hit hard in 2008, but should benefit form rising valuations at some point in the future.

4. Activists will benefit from contraction in the hedge fund sector. The bigger, more stable hedge funds that are likely to outlive many of their smaller competitors will be accompanied by activist funds that have solid track records. That institutional investors understand activist strategies, and know that they don’t involve “black box” processes, will also benefit the managers.

5. Anti-shareholder attitudes are passé. So too, apparently, are lavish salaries and perks. After seeing the market capitalisations of their businesses devastated in 2008, company boards and management have become more sensitive to criticism. Knowing that activists can wield legitimate arguments capable of unlocking shareholder value, companies will be more willing to listen in the next two years.

6. Consolidation will happen. Merger and acquisition activity could resume as stronger companies target smaller firms with depressed market capitalisations. But as companies will be reluctant to play hard-to-get when an attractive buyout arrives, activists will be somewhat passive, similar to Pershing Square Capital Management, which has stakes in booksellers Barnes & Noble and Borders, and is pushing the two together.

7. Activists’ longer lock-ups see them put capital to work while other funds withdraw. Heavy redemptions from hedge funds have not impacted the activist funds so heavily, as they hold longer lock-ups over investors’ capital. Hedge funds with the longest lock-ups should be in stronger positions than their competitors, and activists are usually among them, holding capital for between three and five years. They have more capital to put to work, and can mark investments to market each day.

8. Short-selling bans will help. If short-selling is further limited by regulators, long-only investors, including activist funds, should benefit.

9. Activists will seek balance in their portfolios. Many of the investments that made money in 2008 were short-selling bets. Activists will likely include more short plays in their portfolios to balance the predominance of long-only investments, like investors Greenlight Capital and Pershing Square have already done.

10. There is more fuel for activists. The actions, and lack of action, from various corporate boards in 2008 have provided activists with ample opportunities. Even after Enron and Sarbanes-Oxley, poor oversight impaired major businesses such as Bear Stearns, Lehman Brothers, Citi and General Motors. Rob Rubin, director at Citi, lamented that US housing prices were not expected to fall so precipitously. Although no board is omniscient, many were able to protect shareholder capital, to some extent, during the 2008 meltdown. Activists will pressure badly-performing boards, proving that shareholders have learnt much form the financial crisis so far.

The US Federal Reserve has chosen J.P. Morgan to provide custodial services for its program to purchase mortgage-backed securities (MBS) from now nationalised government-sponsored enterprises, Fannie Mae, Freddie Mac and Ginnie Mae.

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Large, diversified hedge funds with institutional-quality operations are more likely to survive their smaller rivals as the sector continues to contract, according to a research note by Morgan Stanley.

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Institutional investors should ‘slowly and carefully’ invest cash reserves in emerging market and high-quality US blue chip equities, says Jeremy Grantham co-founder of GMO, who expects imputed 7-year returns for the sectors to moderately outperform and be substantially better than their averages in the last 15 years.

However, declines to new equity market lows should be expected in the next two years, since market corrections historically overshoot on the downside after major asset bubbles have burst, Grantham writes in his most recent quarterly letter.

The ever-bearish investor predicts that the S&P500 would probably fall to 600 or lower in the next two years, surpassing 750, which was reached in November 2008.

For long-term performance, investors should build portfolios that are more resistant to inflation and less sensitive to potential weakness in the dollar, Grantham writes.

“These are two serious problems that we may have to face as a consequence of flooding the global financial system with government bailouts and government debt.”

But Grantham’s commentary extended beyond government fiscal policy to criticise members of the finance team chosen by US President Barack Obama.

“These are momentous days in which government actions may well have make-or-break impact, but my confidence in government and leadership is at a low ebb.”

The self-proclaimed “contrarian and a nitpicker” tagged Obama’s Treasury nominees as the “Teflon men”, because they failed to question the policies set by Alan Greenspan, the former chairman of the Federal Reserve, or combat the formation of the US housing bubbles. Â

They drew criticism for their apparent links with Robert Rubin, the former US Treasury Secretary and special adviser to Citi as it amassed billions in treacherous mortgage-backed securities. According to Grantham, Rubin “helped to create an environment where prudence was a career risk and CEOs felt obliged to keep dancing”.

Members of the Obama finance team were scathingly labelled “Rubinesque retreads”.

Grantham took aim at newly sworn-in US Treasury Secretary, Tim Geithner, for not questioning Greenspan’s policies during his time as a member of the Federal Open Market Committee.

It was this perceived lack of dissent that concerned Grantham most.

“Our financial ship is not doing a passable imitation of sinking because of a lack of intelligence. What was lacking was the backbone to publicly resist the establishment’s greedy joyride of risk-taking and sloppy standards.

“There was plenty of intelligence, just not too much wisdom. So it would be very encouraging if there were someone included in Obama’s administration who had actually blown the whistle…If only there was someone with real toughness who could do unpopular things.”

The appointment of Paul Volcker, who as Fed chairman helped tame US inflation in the 1980s, to lead Obama’s Economic Recovery Advisory Committee, is an exception. But Grantham lamented the notion that Volcker, with his “preference for high standards of financial integrity and the backbone to push through unpopular but necessary actions,” would likely “resign in a year if they don’t get serious”.

However, Obama’s stress on strong, rapid government spending to combat the financial crisis has countered the “animal spirits” – or widespread negative sentiment – affecting US economy.

“At times like this, animal spirits need nurturing. Obama’s election will help, at least for a while; talking up the power of stimulus will help, and avuncular, optimistic advice from influential figures will not go amiss.”

While liability-driven investing (LDI) has been gaining in popularity for several years among mainly defined benefit pension plans, the strategy and products are about to get an upgrade in sophistication, according to Russell Investments.

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