Ralph Whitworth, co-founder of Relational Investors, isn't resting on his laurels after his headline-grabbing victory over Home Depot in January. If anything, his coup -- CEO Robert Nardelli was ousted, and Whitworth's partner David Batchelder won a board seat -- appears likely to embolden Relational and other activists.
Whitworth's firm, which manages some $8 billion, is considering raising an additional $2 billion from investors. That's bad news for underperforming companies with sloppy management practices but good news for shareholders, especially big pension funds eager to press for better corporate governance. Relational, founded in 1996, has invested the bulk of its assets, nearly $6 billion, in just five holdings: Baxter International, Home Depot, National Semiconductor, Prudential Financial and Sovereign Bank Corp.
"When we started we knocked on a lot of doors where clients said we didn't fit in," says Whitworth, 51. "Now we're mainstream."
The demand for activist strategies, driven chiefly by big public pension funds, shows no sign of abating. Shortly after Nardelli's ouster, the California Public Employees' Retirement System and the California State Teachers' Retirement System invested an additional $300 million in Home Depot shares through Relational, raising the firm's stake in the retailer to some $1.3 billion.
"They're looking to add value, period," Stephen Nesbitt, CEO of Cliffwater, an investment consulting firm in Marina Del Rey, California, says of the big funds. "They've been hesitant because they don't want to be seen in the headlines as leading the charge."
The leading champion of activist investing, CalPERS, is increasing its commitment to the strategy, which already totals some $5 billion, about one quarter of which is invested through Relational. In September, CalPERS decided to allocate as much as $600 million for co-investments with four hedge funds focused on corporate governance: Hermes European Focus Fund, Shamrock, Sparx and Taiyo Pacific Partners.
Just how much money is dedicated to activist investing is difficult to determine, especially as activist hedge funds tend to move rapidly in and out of positions. Edward Rock, a business law professor at the University of Pennsylvania Law School who has studied the subject, reckons the total at $50 billion -- or just a fraction of some $1.4 trillion in hedge fund assets in 2006.
Although the growth in activist investing could shrink returns, as it has in other popular strategies, it has benefited Relational. The firm's investment in Ceridian Corp. got a boost after Pershing Square Capital Management began investing in the Minnesota human resources and information services firm. The shares, which Relational first bought in late 2004, jumped in value by about one third after Pershing Square made its initial investment last fall. Pershing and Relational pushed Ceridian to sell a division that processes credit and stored-value cards. Relational sold the remainder of its Ceridian shares last month.
Recently, Relational has been pushing for the restructuring, and possibly the sale, of disability insurer UnumProvident Corp. of Chattanooga, Tennessee. Relational bought a 4.8 percent stake last year for $300 million. "The question is whether they should remain a small independent in a world of behemoths," says Whitworth.
Relational's hard-line approach has resulted in an impressive track record. On a net time-weighted basis, annualized returns from inception through February 2007 were 18.85 percent, versus 8.95 percent for the S&P total return index. Relational's fund returned 10.58 percent in 2006, and Whitworth doesn't fear a slump. "There will always be a lower quadrant of laggard companies, and that's where we do our work."