Activist investors: a danger to the market or an opportunity for wealth creation?

There has been a surge in day-trad­ing fren­zies, fuelled by the actions of so-called activist investors who use social media plat­forms and online forums to band togeth­er and bet against com­pa­nies and hedge funds.

GameStop became the focus of a trad­ing fren­zy at the begin­ning of this year, surg­ing to a val­u­a­tion of $34 bil­lion after the co-ordi­nat­ed actions of ama­teur investors via online trad­ing dis­cus­sion groups like r/wallstreetbets, found on Red­dit. The col­lec­tive actions, plot­ted on online forums, can dri­ve up stocks that hedge funds have bet against, aim­ing to pun­ish the big play­ers in the stock mar­ket.

At the cen­tre of this was Robin­hood, the trad­ing app that became the vehi­cle for ama­teur investors to take on Wall Street and teach hedge funds a les­son in the GameStop deba­cle. How­ev­er, when Robin­hood sus­pend­ed trad­ing on GameStop, retail investors were out­raged, claim­ing the move had pro­tect­ed the hedge funds and insti­tu­tion­al investors.

While some her­ald activism as democ­ra­tis­ing finance, oth­ers warn that online threads are lead­ing young and inex­pe­ri­enced investors to make wild and risky bets, and put vast amounts of per­son­al cap­i­tal at risk.

While activist invest­ing is noth­ing new, the GameStop inci­dent is very dif­fer­ent to nor­mal behav­iour.

“This is nor­mal­ly about buy­ing shares in under­per­form­ing com­pa­nies and then using share­hold­er influ­ence to effect change such as remov­ing the board or man­age­ment, alter­ing the strat­e­gy or restruc­tur­ing the busi­ness to improve prof­itabil­i­ty and share­hold­er returns,” says Jason Hol­lands, man­ag­ing direc­tor of Bestin­vest, the online invest­ment ser­vice.

“This new phe­nom­e­non of pri­vate share­hold­ers pil­ing into a stock like GameStop is very dif­fer­ent. The objec­tive is pri­mar­i­ly to give a black eye to oth­er investors by mis­pric­ing the shares. This upends the whole pur­pose of invest­ing, which should be to allo­cate cap­i­tal with com­pa­nies that will make good use of it and return prof­its.”

A resurgence of equity investments

With peo­ple hav­ing more free time to trade in stocks, alter­na­tive forms of enter­tain­ment closed and gov­ern­ment cash hand­outs wide­ly avail­able, com­pa­nies such as Robin­hood have seen a sub­stan­tial increase in users, says Max­im Man­tur­ov, head of invest­ment research at Free­dom Finance Europe.

In Amer­i­ca, equi­ties have always been seen as the place to invest and now peo­ple who are out of work are look­ing for alter­na­tive ways to cre­ate cash. 

“In the Unit­ed States, peo­ple are com­ing back to equi­ty mar­kets to boost incomes that have been reduced through the response to the pan­dem­ic,” says Stu­art Lane, chief exec­u­tive of Trade Nation. 

“This is being encour­aged by the record highs being hit on the major indices, plus fear of miss­ing out. Also, for many peo­ple, trad­ing is an expres­sion of indi­vid­u­al­ism and an oppor­tu­ni­ty to take risks at a time when many feel their free­doms are being cur­tailed in oth­er ways.”

Anna-Sophie Hartvigsen, co-founder and part­ner of Female Invest, says that while activist investors may cause large fluc­tu­a­tions in indi­vid­ual stocks, they are unlike­ly to impact the over­all mar­ket. The best way to guard against sin­gle-stock fluc­tu­a­tions is to diver­si­fy risk and invest across dif­fer­ent stocks and asset class­es.

“In many ways, the risk of activist investors is no dif­fer­ent than any oth­er type of risk and there­fore the solu­tion is the same,” she says.

The fren­zy over app-trad­ing risks lur­ing inex­pe­ri­enced investors into over­priced and under­achiev­ing com­pa­nies, says Hol­lands. It gives the impres­sion that “play­ing the stock mar­ket” is a get-rich-quick game built on short-term share price move­ments.

“In real­i­ty, true invest­ing is about buy­ing great com­pa­nies for the long term and not short-term spec­u­lat­ing,” he says. 

The risks of joining the online ‘hype train’

Reg­u­la­tion has not yet stepped in because it will always lag behind inno­va­tion, say Fioren­zo Man­ganiel­lo and Nes­sim-Sariel Gaon, co-founders of the LIAN Group.

“Plat­forms like Reddit’s wall­street­bets pro­vid­ed the pos­si­bil­i­ty of rapid­ly shar­ing mate­r­i­al infor­ma­tion and an envi­ron­ment where the ‘lit­tle guys’ can join forces against the insti­tu­tion­al investors, squeez­ing out their short posi­tions on com­pa­nies like GME, AMC and Black­Ber­ry,” accord­ing to Man­ganiel­lo and Gaon.

“While this has all been great fun for some of the mar­ket par­tic­i­pants, there is con­sid­er­able risk and loss­es borne by the investors who joined the ‘hype train’ late and endured con­sid­er­able loss­es in the process. Many of them could trade with lever­age, get­ting exposed to addi­tion­al risk.”

Indeed, “meme stock” sto­ries, like the GameStop saga, mere­ly act as exam­ples of how eas­i­ly inex­pe­ri­enced investors can be pulled into mak­ing poten­tial­ly dam­ag­ing finan­cial deci­sions, says Edgar de Pic­ciot­to, co-founder at iki­gai, a pre­mi­um bank­ing and wealth man­age­ment fin­tech.

Soar­ing price momen­tum in stocks, where the only appeal is a vocal com­mu­ni­ty of investors buy­ing into them, is huge­ly risky

Ben Hob­son, mar­kets edi­tor at Stock­o­pe­dia, says hedge funds and deep-pock­et­ed investors have always tak­en big stakes in trou­bled com­pa­nies so they can influ­ence board-lev­el deci­sions.

He says the risk isn’t so much about activism but more to do with the age-old stock mar­ket prob­lem of investors herd­ing togeth­er to cre­ate bub­ble-like con­di­tions. 

“Soar­ing price momen­tum in stocks, where the only appeal is a vocal com­mu­ni­ty of investors buy­ing into them, is huge­ly risky. With­out a good qual­i­ty busi­ness or attrac­tive val­u­a­tion, things can get very volatile very quick­ly,” says Hob­son. 

Seth Ward, co-founder and chief exec­u­tive at Pynk, says investors, par­tic­u­lar­ly large ones, have nev­er before had to answer for their actions.

“It’s almost impos­si­ble to hide what you do today. And the con­se­quences of busi­ness deci­sions have nev­er been more appar­ent,” he says.

His advice is to keep apply­ing stan­dard, best prac­tice, long-term invest­ment strate­gies, for exam­ple diver­si­fi­ca­tion will give you good pro­tec­tion against one or two shares mov­ing out of sync with the fun­da­men­tals for a peri­od of time. 

Also, keep­ing an eye on invest­ment sub­red­dits might help you in more ways than one; it’s an impor­tant part of the mar­ket and might give you some fresh per­spec­tive, which is rarely a bad idea. “Don’t over lever­age, don’t invest more than you can afford to lose,” says Ward.

New opportunities for active management

Social media chat rooms are begin­ning to resem­ble the squawk box­es on fast-paced trad­ing floors, says Michael Kamer­man, chief exec­u­tive of online trad­ing venue Skilling. 

“What start­ed out as a com­bi­na­tion of vast num­bers of remote work­ers look­ing to take up trad­ing with more time on their hands, cou­pled with greater volatil­i­ty in finan­cial mar­kets and the rise of dig­i­tal bro­ker­ages, has evolved into a retail trad­er mind­set rev­o­lu­tion,” he says. 

Yet, if any­thing, prices mov­ing to extremes in both direc­tions cre­ates a more fer­tile envi­ron­ment for fun­da­men­tal active man­age­ment, says Kasim Zafar, chief invest­ment strate­gist at EQ Investors. 

“The biggest les­son from this sort of thing is that invest­ing is a seri­ous busi­ness. It requires skill, care and due dili­gence. If any of these are lack­ing, one runs the risk of being a ‘punter’ rather than an investor,” he says. 

Samuel Leach, chief exec­u­tive of Samuel & Co Trad­ing, says mar­kets are effi­cient and, if peo­ple find a way to ‘beat the sys­tem’, this tends to only last for a short time before the mar­ket adapts and removes such arbi­trage oppor­tu­ni­ty. 

“This puts more risk on the retail investors who are putting their life sav­ings into these stocks in the hope that the ral­ly will con­tin­ue,” he says. “With invest­ing, it is a zero-sum game, there­fore for you to win, some­one else must lose.”

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