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Hedge funds have been the worst-performing asset class so far in 2016. As a result, investors have withdrawn more than $56 billion from the category through August. While the worst-performing hedge funds you read about are the behemoths like Tudor and Brevan Howard, the sub-$1 billion hedge fund category is taking more than its share of losses, with the number of such funds down almost 20 percent from their all-time highs in 2008.

Plainly, poor performance is the culprit for this rush for the exits. The average hedge fund has returned just 1.6 percent year to-date, less than one-third of the return on the S&P 500. Much of these dollars is flowing into passively-managed and private-equity funds.

At first blush, many public-company management teams are happy about this development, as it means fewer short-term holders in their stock and less short-term oriented questions on earnings calls and sell-side conferences. Many, however, mistakenly believe fewer hedge funds owning their shares will lower their stock’s volatility. Unfortunately for micro- and small- cap stocks, it is likely to results in just the opposite. Smaller hedge funds have played an important role in created volume in many small-cap stocks, often providing liquidity for a large seller to divest shares in a more orderly manner. In addition, smaller hedge funds have been important prime broker clients for many of the smaller research shops, which are now finding it tougher and tougher to make money covering stocks below $1 billion in market capitalization.

Management teams at these companies need to move quickly to attempt to attract new investors and research into the story. Three must-dos for the remainder of 2016:

  • Beef up the company’s own investment story:
    • Strengthen the content on the investor relations website by creating a robust corporate profile, expanding the Q&A section to include the issues most raised in the quarterly earnings process and other content that provides a comprehensive, transparent view of the business and management’s strategy for enhancing shareholder value.
    • Provide more strategic information in earnings press releases rather than simply reciting the MD&A.
    • Create a “101” presentation about the company and have the investor relations team review it with key new target investors prior to meetings. Sell-side analysts used to provide this important service prior to NDRs. It will serve to waste less of management’s time on industry and basic company information.
    • Participate in more of sell-side conferences: Management teams are noticing attendance at sell-side conferences are down and the quality of knowledge of the attendees is getting weaker. Management teams need to manage their own one-on-one schedule more aggressively by declining meetings that won’t be fruitful, and even making time in larger cities to meet with buy-siders not attending the conference.
    • Target actively managed hedge funds: Hedge funds remain an important class of investor in many companies. Smaller companies should spend 20 percent of management’s time targeting actively managed hedge funds with lower turnover levels – under 100 percent is a starting point. Many of these funds hold core positions longer than their turnover rate would imply. These funds can provide needed liquidity, and since most don’t aggressively short, won’t impact days to cover significantly. 

If Dan Loeb founder of Third Point is right and we are “in the first innings of a washout in hedge funds,” this “take charge” attitude of small-cap company management teams and their investor relations officers will become standard practice.

 

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