When hedge fund ValueAct Capital gobbled up a 2 percent stake in Morgan Stanley a few weeks ago, it reignited a speculative thread that has cropped up repeatedly in 2016: activist investors could soon be storming the gates at Goldman Sachs, Bank of America and the rest of the major banks.
At first blush, it seems like a natural move. Investors expect a return on equity of 10 percent or more from banks. Of the big boys, so far only Wells Fargo has been able to top that threshold, while Morgan Stanley and Goldman Sachs languish around 6 percent. Those two, together with Citigroup and Bank of America, are all trading below their book value.
There is a sense that these institutions have been slow to evolve to the new reality, preferring to sit on their mountain of clout and muddle forward on inertia alone. Sure, Goldman Sachs has a retail arm now, and Wells Fargo is inching into investment banking. And while that might terrify Elizabeth Warren, it’s happening too slowly for investors.
What better remedy, then, than a kick in the board from the activist class?
“Enough of a free ride for these management teams,” CLSA analyst and perennial bank gadfly Mike Mayo told the Financial Times. “There’s only so long investors can sit around waiting for adequate returns.”
When it comes to returns, the case for activist intervention at the big banks seems even more natural. Because if there’s anyone who knows lousy returns lately, it’s activist hedge funds.
That fact was made strikingly clear in a recent survey from Preqin, which showed that virtually every institutional investor thinks activists have fallen short of expectations. Apparently not a single money manager surveyed believes that their activist buddies had met the mark.
Of all the hedge fund strategies, activists have had one of the worst records in recent months, losing 0.38 percent in the first half of 2016. As a whole, they’ve cooled their jets compared to a busy 2015 while watching billions of dollars in asset outflows.
The start of the year was particularly painful, and the market is littered with evidence of activist woes. The most glaring example was Valeant Pharmaceuticals. A year after Bill Ackman led a rush of hedge funds into what he called “a very early-stage Berkshire Hathaway,” the stock has plummeted more than 90 percent.
Given that record, then, how hopeful should investors be that the Ackmans and Carl Icahns of the world can shake up the banks?
Icahn has had limited success with AIG, the insurer whose designation as a “systemically important financial institution” exposed it to sharply increased regulatory scrutiny. Icahn won representation on AIG’s board in May, and though the company has resisted the hedge funder’s calls to split itself up to rid itself of the SIFI label, it has lavished investors with $25 billion in promised shareholder payouts while slicing costs.
But AIG is no bank. The difficulties run much deeper with lenders whose costs of capital have risen beyond the returns they’re seeing. In the years since the financial crisis, big banks have groaned under the weight of Dodd-Frank financial regulations and trading conditions that no longer provide a conveyor belt of all-but-guaranteed profits. In particular, heightened capital requirements from the Federal Reserve have dampened profitability across the board.
If activists want to push cost cuts, the banks have already beaten them there. Every major lender has pursued vigorous cost cutting measures, from trimming travel budgets to ditching Bloomberg terminals.
Other factors putting a damper on returns probably fall under the category of things activists should have the serenity to accept. The Federal Reserve is immune to Icahn tweets; even if it hikes interest rates before year-end, a 25-basis-point bump won’t move the needle on returns quite enough. The more explosive option – pushing for breakups that would slim down the unwieldy banks and relieve them of regulatory burdens – would likely encounter stiff pushback.
Finally, there’s the size issue. ValueAct’s $1.1 billion purchase of Morgan Stanley shares bought it just a measly 2 percent ownership stake. The market cap of JPMorgan alone is more than double the entire assets under management among activist investors – estimated by HFR to be around $113 billion. It would be a colossal and risky effort to scrape up the resources necessary to sway just one of the majors.