Thesis: The influence of Hedge Funds on Share Prices

David F. Benkelberg

MODULE NUMBER MBA 2006

INDIVIDUAL PROJECT The influence of hedge funds on share prices

SUPERVISOR Michael A.H. Dempster

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This paper examines the extend to which hedge funds influence share prices of

publicly traded companies, by looking at 46 hedge fund related events in

Germany between January 2004 and July 2007. There are multiple ways through

which hedge funds could push up the price of a share, most notably through

direct activism, i.e. facilitating corporate change in the target firm that improve

performance as well as through playing out market psychology, i.e. making the

market believe that the target in current undervalued. Unlike related studies in the

U.S. which found that hedge funds do have a positive influence on target shares,

my research can not find proof for positive (or negative) abnormal returns

attributable to hedge funds. The mean abnormal return of the 46 events is only

2.2% when benchmarked against the market index and only 1.3% when

benchmarked against industry peers. Both values are statistically not significantly

different from zero and can therefore not be used as proof of the hypothesis that

hedge funds do have a positive influence. The different findings from the U.S. are

explained by the fact that Germany still stresses stakeholder value over

shareholder value and that shareholder activism isn’t a recognized part of German

corporate Governance.

There are, however, a few occasions where hedge funds evidently did have a

directly attributable (short-term) influence on share prices so that overall the

report concludes that while hedge fund’s influence on German shares is weaker

than in the U.S., in some cases hedge funds are able to make a difference.

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―Are powerful fundamental factors at work to

keep the market as high as it is now or to push it even

higher, even if there is a downward correction? Or is

the market high only because of some irrational

exuberance— wishful thinking on the part of

investors that blinds us to the truth of our situation?‖

Robert J. Shiller

4

Abstract ................................................................................................................. 2

1 Introduction ................................................................................................. 5

1.1 Background .............................................................................................. 5

1.2 Objective .................................................................................................. 8

2 Hedge Funds ............................................................................................... 8

2.1 What is a Hedge Fund ............................................................................ 9

2.2 Types of Hedge Funds .......................................................................... 10

2.3 Activist Hedge Funds ........................................................................... 11

2.4 Implications for the Study .................................................................... 12

3 Share Prices................................................................................................ 13

3.1 Common Valuation Methods ............................................................... 13

3.2 Psychological Effects ............................................................................. 14

3.3 Random Walk ........................................................................................ 15

3.4 Can Hedge Funds Influence Share Prices? .......................................... 15

4 Quantitative Analysis ............................................................................... 19

4.1 Methodology ......................................................................................... 20

4.2 The Hypothesis ...................................................................................... 24

4.3 Analysis of 46 Hedge Fund Related Events ........................................ 26

4.4 Findings ................................................................................................. 32

5 Conclusion ................................................................................................. 33

References ........................................................................................................... 36

Appendix ............................................................................................................ 39

A. Hedge Fund Events ............................................................................... 39

B. Hedge Fund Event Data ....................................................................... 41

C. Performance Graphs ............................................................................. 42

D. Hedge Fund List .................................................................................... 57

E. Hedge Fund Managers ......................................................................... 61

F. Hedge fund strategy categories (as per TASS database) .................... 62

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Hedge funds have already been around for over half a century. The first

hedge fund was founded by Alfred W. Jones in 1949 and it was called a hedge

fund because Jones hedged his long positions through using short positions. Jones

idea was to outperform the market while at the same time reducing his risk

through hedging and therefore he called his investment fund a “hedge fund”.

Nowadays hedge funds are widely known as very risky investments. The famous

hedge fund manager Mario Gabelli wrote in 2002: "Today, if asked to define a hedge

fund, I suspect most folks would characterize it as a highly speculative vehicle for

unwitting fat cats and careless financial institutions to lose their shirts" (McWhinney,

2005). In fact, research has shown that hedge funds indeed are highly speculative

and risky. Research by the European Central Bank (Garbaravicius and Dierick,

2005) estimates that first year failure rates of hedge funds are in the range of 2%

and 4%. A more detailed study by Chany, Getmansky, et al. (2005) found an

annual attrition rate of 8.8% for the period 1994-2003. The found that the risk

involved differs for different investment strategies and goes up to 14.4% attrition

rate for managed futures strategy hedge funds. Further, they estimate the average

liquidation probability for funds in 2004 is over 11%, which is higher than the

historical unconditional attrition rate of 8.8%. With a yearly attrition rate of 11% it

is fair to say that hedge funds are indeed risky investment vehicles. In July 2006

the Securities Exchange Commission (SEC) estimated that there were 8,800 hedge

funds, managing total assets of $1.2 trillion (Cox, 2006). With such large numbers

of hedge funds and high attrition rates it is not surprising that every year

hundreds of hedge funds are liquidated, yet once every few years, when a major

hedge fund collapses, such event is popularized in the news and the public gasps

in disbelieve at how such a large fund can collapse. Famous examples are Long

Term Capital Management in 1998 (which was probably the first time that many

people ever heard the term hedge fund), Tiger Funds in 2000 and very recently

Bear Stearns in 2007. Due to their high leverage and their sheer volumes (mostly

financed by leverage), financial distress of major hedge funds can cause an

avalanche, putting banks and private investors equally at risk. It is therefore of

little surprise that hedge funds receive an increasing amount of press coverage,

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which, mostly reporting bad news, leads to ill feelings amongst the average

population.

Figure 1 - Hedge Fund Growth

In April 2005 Franz Müntefering, former German Federal Minister of Labour

and Social Affairs, publicly called private equity firms locusts, and quickly,

through the yellow press, this term was adopted for hedge funds as well. Hedge

funds and private equity firms are confused by many Germans and both are seen

as equally greedy and destructive. Only shortly afterward Müntefering’s public

condemnation of private equity firms the G7 started talks about regulating hedge

funds and as of today their talks are still ongoing (Dougherty, 2007). The German

government has expressed concerns that a collapse in the hedge fund industry,

which could be triggered by the collapse of one of the big hedge funds, could lead

to global disorder. This is a rational fear, not only because hedge funds are

inherently risky and their numbers and their managed assets are increasing, but

also because they are not regulated and because their share on financial

transactions is much bigger than one would assume (Braun, 2007). Almost as a

proof of such a theory, the recent collapse of two Bear Stearn’s hedge funds has

caused ripple effects which as of today have already impacted two German banks.

According to the International Herald Tribune hedge funds are controlling assets

worth $1.4 trillion (Dougherty, 2007). Alpha Research Inc. estimates that the

largest 100 hedge funds alone manage $1.1 trillion (Rose-Smith, 2006) and further

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estimates project hedge funds to grow 300% over the next five years (Schiller,

2006). These numbers by themselves are quite impressive. Yet, more relevant is the

finding that 40% to 50% of all trade at the U.S. and U.K. stock exchanges is

conducted by hedge funds (Braun, 2007; Schiller, 2006; Atzler 2005b). Considering

the value of assets controlled by hedge funds, their predicted growth rate as well

as and their already high level of trade, it is apparent that hedge funds have a

significant influence on today’s financial markets.

While it is therefore justifiable to assume that hedge funds have a

considerable impact on the stability of financial markets and share prices there is

only little quantifiable evidence of these assumptions. Some recent studies, most

notably those by Brav, Jiang, Partnoy and Thomas (2006), Klein and Zur (2006)

and Boyson and Mooradian (2007) are providing hard evidence that hedge funds,

on average, are not an evil but a blessing to the average shareholder in the way

that they act as shareholder advocates and agents for corporate change. All three

studies find that hedge fund activism generates between 7% to 10% abnormal

return with no apparent reversal over the following years.

Not surprisingly, most of the studies available on hedge fund activism and

its impact on corporate governance and on share prices are focusing on the United

States. The U.S. is the biggest financial market in the world with some of the

world’s biggest stock exchanges. Also, the majority of hedge funds is located in

the U.S. However, this doesn’t mean that hedge funds don’t operate globally. On a

global scale hedge funds “only” manage 5% of total global assets (Schiller, 2006),

but the biggest 100 hedge funds alone could completely buy Germany’s biggest 30

companies (the DAX30) and would still have spare money to spend (Süddeutsche

Zeitung, 2007). That’s of course only a hypothetical statement but recent estimates

show that 20%-30% of all German DAX and MDAX shares are owned by hedge

funds (Atzler, 2005a). This means that around one quarter of Germany’s biggest

companies is controlled by hedge funds.

Given the increase in hedge funds and the increase in assets managed by

hedge funds it is rational to assume that competition among hedge funds is

growing. Goetzmann and Roos argue that as a result of this increased competition

hedge funds are more and more investing in new regions and are using new

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strategies. The overall goal that unites all hedge funds is that they are trying to

beat the market (Goetzmann and Ross, 2000). During the 1990s a lot of hedge

funds specialized in arbitrage trading (Goetmann and Ross, 2000), however, with

the increase in competition such arbitrage opportunities become more difficult to

find. As a result hedge funds are turning to alternative strategies, including hedge

fund activism (Klein and Zur, 2006) but they also invest more and more outside

the U.S, for example in Germany .

Since Franz Müntefering in his speech in 2005 called hedge funds “locusts”

hedge funds have gained significant attention by the German public. Müntefering

of course was not the initiator; he was only the catalyst that started a debate

throughout which hedge funds emerged as one of the great evils of the 21st

century. This prompts the question if hedge funds in Germany are correctly brand

marked as locusts or whether they maybe even exert a positive influence on the

market as the above mentioned studies from the U.S. have found them to be.

I have explained that hedge funds have a quite substantial equity position in

the German financial market. Recent research on the U.S. market has shown that

hedge funds can have quite a positive impact on share prices and that their overall

influence is quite positive, whereas their image in Germany is that of short-term

investors who destroy companies like locusts.

In this paper I will explore the role that hedge funds in Germany really play.

I will verify if conclusions similar to those from U.S. studies can be drawn with

regards to the German market. More specifically, I will analyze if hedge fund

activity in Germany has a positive influence on share prices, i.e. if hedge funds,

through one way or another, increase the value of shares that they invest in.

Before diving into the analysis of the data I need to come back to the general

definition of hedge funds as this is relevant for the research. The objective of this

research is to analyze this impact of hedge funds on share prices, in particular for

the German market. I have already shown that in the public eye it is often difficult

to differentiate between hedge funds and private equity firms. Also, the objective

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of this study would lead to conclude that this research needs to include all hedge

fund activities. However, I have already referred to the subset of hedge funds,

namely activist hedge funds that play an important role. In this section I will

define what activist hedge funds are and why I focus on them rather then

including all hedge funds. Before I get to this, there are two key points that require

clarification: first, what exactly are hedge funds, and, second, what different types

of hedge funds exist.

Ronald Lake, a practitioner working for a large hedge fund, defines hedge

funds based on merely two characteristics: ―(i) they are commingled pools that are

offered via private placements to a relatively limited number of institutions and

sophisticated investors, and (ii) the manager receives an incentive fee” (Lake, 2003). That,

as he admits himself, is a fairly loose definition but at the same time it is also very

precise. The problem with hedge funds is that they indeed need not share many

common characteristics and the way they are trying to beat the market differs

quite substantially. Brav et al. (2006) take a similar approach and also define hedge

funds by their key characteristics but they find four common characteristics: “(1)

they are pooled, privately organized investment vehicles; (2) they are administered by

professional investment managers; (3) they are not widely available to the public; and (4)

they operate outside of securities regulation and registration requirements”. Especially

the last point, that hedge funds operate outside of securities regulation has

recently been a point of great concern and at the same time, poses a challenge for

any hedge fund related research. Since hedge funds are not regulated, they are not

obliged to inform anyone of their existence. They don’t have to register with a

central body and therefore no central data source exists that lists all hedge funds.

Despite their commonalities, hedge funds are not a homogeneous class of

investments; rather their commonalities are often restricted to the above four

points. How they actually invest their money differs quite substantially. There are,

however, sub-classifications of hedge funds which can help in understanding

which hedge funds are more and which are less relevant to this study.

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Like all investment funds hedge funds aim to generate a return. Goetzmann

and Ross (2000) very nicely nailed this down to the point that the purpose of

hedge funds is to yield absolute returns above the benchmark of the riskless rate.

There are many ways hedge funds are trying to achieve this. The majority of

hedge funds describe themselves as long/short equity, which is close to what

Alfred Jones’s original concept of hedge funds stood for. Besides that, there are

many different approaches used to exploiting market opportunities. The TASS

database, which is still widely used by hedge fund managers, uses 11 broad

categories (see appendix for detailed definitions).

Convertible Arbitrage: The hedge fund manager focuses on discrepancies

between a convertible bond and the corresponding equity and “works the

spread”. For example, he buys a convertible bond and sells short shares of

the same company

Dedicated Short Bias: The manager emphasizes short positions in the

market

Emerging Markets: The fund manager focuses investments in securities of

companies from developing (emerging) markets

Equity Market Neutral: The hedge fund manager balances long and short

positions

Event Driven: The manager analyses opportunistically uses special events

such as merger situations (merge arbitrage), distress situations, regulatory

changes by anticipating how these events will influence the share price and

using long or short positions accordingly

Fixed-Income Arbitrage: The manager uses mixed short and long positions

of related bonds with different yields

Global Macro: The fund manager makes use of price differences of similar

investments in different financial markets around the world (relatively

mispriced)

Long/Short Equity: This strategy generically describes any strategy that

uses hedged investments in equities

Managed Futures: The manager seeks basis convergence from underlying

future prices in options

11

Multi-Strategy: Multi-Strategy is a combination of any of the above

strategies

Fund of Funds: The manager will invest in other hedge funds (at least two,

often more)

The above list is most likely not complete. In fact, the hedge fund market is

evolving quickly and once in a while new strategies appear such as risk arbitrage

(event related securities whose price differences imply different probabilities for

an event), and statistical arbitrage. There is also a special form of hedge funds

which could be classified as arbitrage or as event driven or as global macro but in

fact doesn’t quite fit into any of these categories and some refer to this category as

activist hedge funds.

Up until around 2000, most hedge funds profited from their ability to

identify and capture trading opportunities, mostly arbitrage opportunities

(Goetzmann and Ross, 2000). However, the rapid growth of the hedge fund

industry has made it more and more difficult for managers to identify and exploit

these arbitrage opportunities. As a result, many funds have turned to an

alternative strategy – hedge fund activism (and new regions such as emerging

markets) is just one example but one which is of high relevance to this research.

Klein et al. (2006) define hedge fund activism as a strategy “in which a hedge

fund purchases a 5 percent or greater stake in a publicly-traded firm with the stated intent

of influencing the firm’s policies”. I agree with their statement with the exception of

the 5% stake. The 5% stake is an arbitrary choice and the reason why they picked

5% is because that a 5% stake triggers a 13D filing to the SEC which makes their

research easier. There is simply no other reason. The key message however is that

activist hedge funds actively seek to influence the target firm.

In some cases, especially when facing strong opposition from the target’s

management, activist hedge funds form wolf packs or buy shareholder voting

rights through undisclosed transactions, for example through the stock lending

market (Hu and Black, 2006 and Christoffersen et al., 2006). Through such tactics

activist hedge funds are capable of influencing large international corporations of

12

which they otherwise had o means to accumulate a significant enough block of

shares (>5%) to exert enough influence.

The main leaning out of this is that activist hedge funds, while being a small

group, are the group of hedge funds which is most likely to have direct,

measurable impact on share prices, fundamentally for two reasons: First, it is their

strategy to increase the target’s share price through activism and second, they go

public about it which makes it easier to track and measure their influence.

Overall, there is neither a clear definition of hedge funds, nor a complete list,

and also there is no central record of the dealings of hedge funds. To a large

extend it is just not possible to track which hedge fund invested into which stocks

and when. This lack of data could be regarded as a considerable shortcoming to

this research, but I argue that to the extent that hedge funds trade on the market

anonymously, i.e. without anyone knowing when and into which stock they

invest, hedge funds are not any different from any other institutional investor

such as mutual funds. Arguably, they may have an impact due to the increased

volume of trade, e.g. the market is more, and there are fewer and smaller arbitrage

opportunities. However, overall, anonymously trading hedge funds act like other

institutional investors, which, as Karpoff (2001) and Barger (2006) have shown, are

unable to generate any abnormal returns despite their activist efforts. Therefore,

there should be no notable significant impact on share price movements

attributable to non-activist hedge funds1.

On the other hand, some hedge funds specialize in activism, i.e. they are

trying to actively influence the share price of certain stocks through different

means, primarily through putting pressure on management to initiate changes.

Such activist hedge funds do not act like normal, anonymous investors (Clifford,

2007; Boyson, 2007; Allaire et al. 2007). These activist hedge funds are those most

relevant for this research since they are explicitly aiming to increase share

performance.

1 There is one exception though, namely small manipulations due to have trading and rumours. Recently a claim has been made by an insider that hedge funds can and do manipulate share prices as needed, i.e. if they have a short position they can manipulate the price of the share to go down. Such claim hasn’t been substantiated yet and this kind of exerted influence is beyond the scope of this research.

13

Finally, some private equity firms act similar to activist hedge funds. Since

many people in Germany can’t even tell the difference between the two and since

their actions are often alike, i.e. they buy blocks of shares in companies in order to

exert pressure onto them, I have included some private equity activism events in

my analysis as well.

Since in this study I focus on the influence of hedge funds on share prices it

is inevitable to take a small detour into the fundamentals of share prices. It is

important to understand what drives share prices in order to understand the

specifics of how a hedge fund could influence them.

Generally speaking, share prices express expectations. Owning a share is not

so much a matter of owning a part of a company, but it is in most cases primarily a

financial investment. Investors invest their money in shares in the expectation to

get a return. As regards shares, there are two sources of income for the investor:

dividend payments and an increase in the share price (capital gains). The price

that an investor is willing to pay for a share is thus dependent on the investor’s

expectations of future dividend payments and capital gains. Dividend payments

depend of the firm’s potential to pay dividends which in turn depend on the

firm’s earnings growth.

While most shares are bound to deliver a return, they are not equally likely

to do so. Investments in share aren’t equally risky and since shares aren’t the only

possible investment form they compete amongst each other and against other

investments such as bonds. A reasonable investor who has a large number of

investments to choose from will require a premium for the risk he takes: The

higher the risk, the higher the required premium.

Thirdly, the value of a share should be based on its potential to generate

future earnings. Such future earnings need to be evaluated. There are different

evaluation methods to do so but all methods share one important common aspect.

All evaluation methods are forward looking and therefore they are based on

assumptions: Assumptions on earnings growth, assumptions on interest rates, and

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assumptions on risk. As with all assumptions, an investor can never be certain

about any of them.

To actually convert expectations into quantifiable numbers, investors apply

various valuation models. Two of the most famous models are the Dividend

Discount Model (DDM) and Free Cash Flow Analysis (FCF).

Like all other fundamental valuation methods the DDM and FCF valuation

models are calculating the value of an equity based on income streams, assuming

a yearly growth factor and discounting the income by a discount factor. The risk of

the equity return in these models is encapsulated in the discount rate. These

models may be overly simplistic and professional dealers are likely to rely on

much more sophisticated models, but the underlying flaws are still the same. It is

easy to see that expectations about income streams (regardless of whether they are

dividends or cash flows), about growth rates and about risk are all forward

looking assumptions and small changes to these assumptions often result in

significantly higher or lower valuations. More complex models may be more

sophisticated but they still rely on assumptions as input parameters. Quite often

the current market value is used as a reference point against which one’s own

valuations are benchmarked against. This is following one of the fundamental

theories that “the market” is efficient and that the bulk of buyers and sellers, when

in equilibrium, can’t be wrong. There is therefore a strong psychological (peer)

effect underlying most assumptions which normally biases towards the market

average.

Robert Shiller (2000), after analyzing the market of the 1990s, found that

prices are sustained not by real fundamental factors but by investor enthusiasm.

Many investors don’t buy shares because they believe in their real intrinsic value

or future dividend payments, but because they are certain they can sell the shares

to someone else at an even higher price. Simply speaking, “stock prices are driven by

a self-fulfilling prophecy based on a large cross section of investors” (Shiller, 2000).

Nowadays this effect is often referred to as the “greater fool” theory – there

is always a greater fool who will pay even more for the share. The greater fool

theory is also the reason behind stock market bubbles (Fisher and Statman, 2002).

15

If all investors relied on hard facts and fundamental evaluation methods than it

would be unlikely that large bubbles could ever exist.

In 1973 Burton Malkiel published his book “A Random Walk down Wall

Street” in which he introduced the “the random walk” theory. He suggested that a

blindfolded chimpanzee throwing darts at the Wall Street Journal could pick a

portfolio which would perform just as well as that of an expert. What he meant by

this is that share prices seem to go up and down randomly. Over the long term the

market will work efficient but in the short term it is impossible to predict if the

price of a share will go up or down and hence it is not worse the time or money to

even try to outperform the market. Hedge funds managers of course can not, by

definition, agree to such theories since the sole purpose of a hedge fund to achieve

just that, namely to outperform the market. I mention this theory for three reasons:

1. If the random walk theory holds, then also hedge funds should, over the long

run, not be able to outperform the market. 2. If my research finds that shares of

firms targeted by hedge funds outperform the market, then that would trigger a

follow-up questions, namely if this is due to the hedge fund’s stock picking skill

(contravening the random walk theory), due to the influence of the hedge fund

(e.g. activism), or due to pure luck. 3. If my research finds that hedge funds do

influence share prices (i.e. hedge funds are found to be the reason for share prices

going up or down), than the share price movement would be proven to not be

totally random which would open up arbitrage opportunities. If hedge funds

investments into a share do have an influence, than such hedge fund deals, i.e. a

hedge fund investing in a particular share, could become the trigger for other

investors to also buy the same share since at that point it becomes likely that the

share price is going up (or down if the hedge fund influence is negative). Such

situation would than lead to a self-fulfilling prophecy since many investor

jumping onto the wagon would increase demand for the share, resulting in a

higher price.

In this paper I am analysing the influence of hedge funds on share prices.

Now that we have reviewed the factors underlying share prices it is time to apply

that understanding to the question underlying this research. If the hypothesis is

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that hedge funds do have an influence on share prices then this automatically

leads to another question: How is it possible that hedge funds influence the price

of a share? The share price, after all, is the equilibrium of buying and selling prices

which are based on assumptions around profitability, growth and risk. Common

theory would conclude that hedge funds ability to influence the price of a share

must stem from a direct influence on the underlying fundamentals (profitability,

growth, risk). If none of the fundamentals change than the share price shouldn’t

change, unless it’s a bubble. The question then is: Can hedge funds change the

underlying fundamentals?

If through activism a hedge fund could indeed make a firm more profitable,

i.e. generate more free cash flow and generate more growth, than that would

justify an increase in the share price. Klein et al. (2006) identify two strategies

through which hedge funds can improve the target firm’s performance. First,

hedge funds can alter the firm’s strategy, including the redirection of investments

to more profitable (and more risky?) projects but also by divestment, i.e. selling of

less-productive assets. Second, hedge funds can reduce agency cost by forcing the

firm to reduce its excess cash holdings which can be achieved by changing the

gearing, increasing dividends or paying extraordinary dividends or by buying

back shares. Jensen (1986) specifically suggests that a firm can reduce its agency

costs associated with excess cash by paying out dividends to shareholders or

increasing debt and interest payments to creditors.

Brav et al. (2006) find that the majority of activist hedge funds resemble

value investors, i.e. they target companies which they believe are undervalued.

They also find that the majority of hedge fund activism tends to fall into the

second of Klein and Zur’s two categories, i.e. they target general changes (e.g.,

payout policy, excess diversification), rather than firm-specific issues (e.g.,

operational difficulty, sales slump) (Brav et al., 2006) and quite often they succeed

with their plans, achieving, on average, 7%-10% abnormal return (Brav et al.,2006;

Klein et al., 2006; Boyson et al., 2007).

This means that in theory at least hedge funds are capable of improving a

firm’s performance, and that this would lead to higher share prices of the target

firm. However, there’s lack of evidence that hedge funds are achieving this in

17

practice. While there is evidence that hedge funds are associated with abnormal

returns of the shares, underlying performance of these firms isn’t really improving

as theory would expect. Brav et al. (2006) find that in two-thirds of all cases

activist hedge funds are successful in attaining their activist objectives (as stated in

their 13D filings) and they also find that hedge fund activism is associated with in

improvement in return (ROE) in the target firm. However, they find this

association to be weak and can’t confirm causality of the association. Zur et al.

(2006) can’t even find a slight improvement in the accounting performance of the

target firms. On the contrary they even find a decline in performance as measured

in ROE, ROA and EPS in the year after the activism. There is therefore little to no

evidence that hedge funds actually do improve target firm’s performance. Yet,

many studies do find that hedge funds activism is associated with a 7% to 10%

abnormal return of the target’s shares. These are two contravening facts which are

hard to reconcile. There must be another reason why hedge fund activism leads to

significant abnormal return. In fact, there are a couple of other factors which can

help explain these findings.

The first such factor is risk. As pointed out earlier investors demand a risk

premium for their investments and accordingly fundamental valuation methods

incorporate risk into the discount rate. Studies by Brav et al. and Zur et al. have

only measured the change in the firm’s performance such as ROE but they haven’t

considered risk. An increase of the share price could be explained by lower risk.

Reduction of agency cost, divestments, redirections of investments – all factors

which their studies founds that hedge funds were able to achieve – can all be

linked to potentially lower overall risk of the firm. For example divestments of

risky assets or risky operations would also decrease the overall business risk of the

firm. Reduced agency cost can be linked directly to better decision making which

can also result in lower overall risk. Maintaining the same ROE and the same

growth while lowering the risk (and thus the discount rate) would result in a

higher share price.

I don’t have any data to support this theory but at least it gives one feasible

explanation for the above discovered discrepancy.

Yet, there are two more factors to consider. Secondly, it has been shown that

hedge funds are responsible for up to 50% of all trade at the world’s major stock

18

exchanges (Braun, 2007; Schiller, 2006; Atzler 2005b; Campos, 2005). How trade

volumes increased over time can best be illustrated by a few examples. In 1960, the

average holding period for shares of a publicly listed company in the U.S. was

seven years. By 1992 the average holding period had shrunk to two years and by

2006 was down to only seven months (Odland, 2006). In other words, the average

annual share turnover for shares listed at the NYSE was:

12% in 1960 73% in 1987 86% in 1999

87% in 2005

(Allaire and Firsirotu, 2007)

NASDAQ figures are even higher, for example the shares of Amazon.com

turned over every seven days (Bratton, 2006). To a large extend these high levels

of turnover are attributed to hedge funds. Such increases in equity trade levels

certainly have a positive influence on the liquidity of the market, but there is also a

downside. Schiller (2006) found evidence that frequent trading caused by hedge

funds causes wild price fluctuations. There are reported cases of shares falling by

more than 30% in a single week after hedge funds had gone after the company.

Through extensive use of short positions or options hedge funds are

powerful enough to put share prices under upward or downward pressure.

Unfortunately, while long positions exceeding certain thresholds must be reported

and are thus made publicly known, trades of options or short positions by hedge

funds mostly take place in secret. Therefore no data for analysis is available and

the exact extend to which hedge funds can influence share prices through such

tactics is hard to estimate.

Yet, there’s also the third additional factor through which hedge funds could

possibly influence share prices: Psychology. As already discussed, all fundamental

evaluation methods are forward looking and thus depending on expectations.

These expectations are all assumptions and no investor or analyst can be certain

that his assumptions are correct. If an investor sees that others are willing to pay a

higher price for a stock, than that investor may be inclined to review and “adjust”

his own assumptions which may then lead him to evaluate the share at a higher

price. Shiller (2000) concluded that “People are prodded into the market, for example, by

19

the constant suggestion of 'the moral superiority of those who invested well' and the ego-

diminishing envy stirred by hearing that others have earned more in the market than they

have in salary.” In other words, self-doubts and uncertainty paired with fear that

one’s own assumptions could be wrong and could be resulting a financial loss or

foregone gains lead to herd behaviour. Kiev (2002) simply boils it down to the fact

that staying objective is difficult and that investors are “consumed with anxiety, self-

doubt, and frustration”.

Hedge funds could use this to their advantage by luring other investors into

thinking that they know something which others do not know. Greed and self-

doubt and anxiety would lead not all but some investors to believe that they are

loosing out on a profitable opportunity, consequently they will buy shares as a

result of which the share price rises. A very nice illustration of such anxiety is a

very recent example from the German stock market where shares in Deutsche Post

AG climbed 2.4 percent merely based on a rumour that a hedge fund might be

building up a stake in Deutsche Post AG. According to Reuters (2007) traders

stated that “Deutsche Post is jumping on rumours that TCI has already bought 3 percent

of the company via the market” and “Obviously something is really cooking there. There

are big two institutions in the U.S. that have been buying in the past few weeks, I don't

know what their intentions are”. Whether the underlying motivation of the hedge

fund is to use the psychological factor to lift up the share price and achieve a quick

2.4 percent profit or if the hedge fund actually is interested in a long term

investment is hard to say but at the same time it is irrelevant. The fact that the

mere rumour of a hedge fund investing is sufficient to increase the share price is

proof that psychological factors play a considerable role and hedge fund could use

this to their advantage.

So far I have presented evidence based on research from the U.S. that activist

hedge funds are able to generate positive abnormal returns in target firms. I have

also shown that the same studies find little to no evidence that these abnormal

returns are related to real performance improvements of the firms. Finally, I have

provided theories that reconcile the above discrepancy, i.e. I have also outlined

20

how hedge funds are theoretically able to boost share prices without improving

the target firm’s performance.

The final part of my research looks at historic market data to give real

quantitative evidence of the influence of hedge funds on share prices. Since

extensive research was already carried out for the U.S. market I have focused on

the German market, which in many ways differs from the U.S. especially with

regards to shareholder value and corporate governance, both of which are

strongly linked to shareholder activism.

Regarding the quantitative analysis, there are some fundamental challenges

to cope with. The first such challenge is that there is no clear definition of how

hedge funds are defined. I have also already referred to the definitions made by

Lake (2003) and Brav et al. (2006) and both give a correct but broad definition.

There is, therefore, no clear definition of what a hedge fund is, and, since hedge

funds aren’t regulated and, thus, aren’t obliged to report their dealings (with some

exceptions, such as Schedule 13D filings) there also is no central database about

hedge funds. A widely used and well renowned data source on hedge funds was

the TASS database (formerly known as the CSFB/Tremont database), ran by

Tremont Capital Management Inc. Allaire et al. (2007), Boyson et al. (2007),

Clifford (2007), Brav et al. (2006) and Chany et al. (2005) all used TASS as a prime

source for their research. Unfortunately Tremont has sold the database to Lipper

and the database is no longer publicly available. Regardless of its unavailability

Brav et al. (2006) have found that only 20-25% of the hedge funds which they had

found manually were actually listed in the TASS database and this finding makes

TASS an incomplete data source anyway. They attribute their finding to the fact

that TASS was using self-reported data from hedge funds and not all hedge funds

report themselves. This once again highlights the downside of lack of regulation

and the difficulty to obtain reliable and comprehensive data for research.

All of the above researchers have also relied on the Security Exchange

Commission’s (SEC) Edgar database which holds all Schedule 13D filings.

Although hedge funds are largely unregulated, section 13D of the Exchange Act of

1934 requires anyone who acquires more than five percent of a public company’s

21

shares to notify the SEC within ten days of crossing the five percent threshold,

resulting in a Schedule 13D filing2. With regards to this Act, hedge funds are

treated like any other investor and are thus equally required to file such disclosure

document which makes the Edgar database a valuable source of data.

In Germany both a similar rule and a similar database exist. Similar to

section 13D of the Exchange Act, §21 of the German Securities Trade Act

(Wertpapier Handelsgesetz, WpHG) requires anyone who crosses a 3%, 5%, 10%,

15%, 20%,25%, 30%, 50% or 70% threshold (in either direction) to notify the

Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) – the German equivalent

of the SEC – within four working days. The BaFin stores such filings in a publicly

available database3, similar to the Edgar database.

However, unlike the Edgar database which keeps all filings, the German

database run by the BaFin only lists current ownership and filings related to them.

This means, it does not keep filings where, for example, a fund exceeds the 3%

threshold but later drops below it again. Once an investor drops below the 3%

threshold, old filings are deleted and no further record will be found in the

database. Since the BaFin only keeps records of current ownership structures,

historic findings are not available, which in the case of hedge funds who trade

frequently, is a considerable downside.

Given the lack of a central data source on hedge funds I used phased

approach to gather the relevant data.

Phase one was primarily aimed at compiling a list of hedge funds,

particularly those who are known as activist funds and those who trade on the

German market.

I used four source of information to compile such a list. First, I used the

Thomson One Banker database which includes a deals section. The deals section

list transactions where one institution bought blocks of shares of another

company. I search the deals database for transactions where the target was a

German company and the buyer was classified with any of the following industry

2 This 5% threshold is the reason why Klein et al. refer to a 5% stake in their definition of hedge fund activism 3 Available at: http://www.bafin.de/database/AnteileInfoWeb/

22

codes: SIC 6282, 6722, 6799, 7389; NAIC: 523910, 523920, VEIC: 9000, 9250,

9299.These industry codes cover financial institutions excluding retail banks. This

search already turned out some relevant deals as well as names of hedge funds

and their targets. Secondly I used the Factiva news database to search for news

relating to Germany (German and English language), including the words “hedge

fund”, “hedge fond” or “hedge-fond”. I noted down all news reports of hedge

funds buying, or intending to buy blocks or shares. I also recorded the names of

all reported hedge funds. Third I used various hedge fund related websites to

gather the names of the biggest, most active and known activist funds. Fourth: I

ran searches on the BaFin database using names of known targets and acquirers

which I had gathered from the previous three sources. The BaFin database would

give me current ownership structure which in some cases led to new names of

other hedge funds.

From all four sources together I was able to gather 400 names (including

synonyms) of hedge funds as well as 30 names of individual investors which own

or manage hedge funds. While this list isn’t exhaustive, it is very unlikely that any

major hedge fund that could have a significant influence on the market would be

left out from my list.

Phase two of the data gathering process was aimed at finding all relevant

German deals where any of these hedge funds or investors were involved. Again,

I turned to the Thomson One Banker database searching for any deals with

German targets where the buyer matched any of the 400 names. I also used the

Factiva news database to search for articles concerning Germany which mentioned

any of the 400 hedge fund names or any of the 30 individuals.

From that search I was able to generate a list of 46 relevant deals.

In phase three of the research I retrieved German market index data (DAX,

MDAX, SDAX, TecDAX) for the period from 1/1/2004 to 31/7/2007 from the

Datastream database. I also retrieved the share prices of all target companies

involved in those 46 deals for the same period. I then used the Osiris database to

generate lists of peer companies for each target (using the Osiris peer analysis

function) and for each peer retrieved share price information.

23

The final data was a comprehensive list of the German market index, share

prices of all involved target companies as well as share prices for all peers

(industry groups) for each target.

Based on research from the U.S. market (Brav et al.,2006; Klein et al., 2006;

Boyson et al., 2007) which showed that activist hedge fund on average deliver

abnormal returns of 7%-10%, the hypothesis for the German market was that

hedge funds would have a similar impact on German share prices.

If hedge funds had a positive influence on share prices then the positive

impact should occur near to the time of the investment (day 0) and should not

reverse thereafter. The data that I used was based on news reports or filings in the

Thomson One Banker database or in the BaFin database. In all cases I assumed

that the deal was not reported on the same day that it took place. The BaFin

requires deals crossing a threshold to be reported within 4 days. At the same time

information about the (planned) deal could have leaked to the market several days

before the deal actually took place. To reflect the delay in reporting and possible

leakage, I have used day0 minus 10 days (T-10) as the reference point for share

price performance. I consider T-10 as the time at which the target share price is

free from influence from the hedge fund deal.

In order to measure share performance, and to validate if target companies’

shares outperform the market, I have used a [-10,+30] day interval around day 0

(reported date of the deal). I compare the target share price [-10,+30] buy-and-hold

performance against the market index buy-and-hold performance (indexes used

are DAX, MDAX, SDAX and TecDAX) as well as against peer industry buy-and-

hold performance for the same perdiod. If hedge funds do have a positive

influence on share price performance than the target stocks should outperform the

market and their peers over the [-10,+30] period.

For control purposes I also looked at alternative time intervals [-30,+30],

[-10,+60] and [-100,+100] to control for any unusual events. As Kahan and Rock

(2006) point out, hedge funds are generally regarded as very short term investors

and their short investment horizons are an issue of controversy. This is mainly

because critics claim that hedge funds short-termism leads to short-term gains

which come at the expense of real long-term shareholder value. If this was really

24

the case than I would expect to see that any abnormal return that hedge funds

generate upon their engagement would reverse shortly after. There would be a

short-term increase in the share price but as other investors realize that there really

is no improvement to the underlying fundamentals, the share price should return

back to its original state. By applying a wider timer interval such as [-10,+60] and

[-100,+100] I can filter out such effects. If share outperform in the [-10,+30] interval

but perform average over a [-100,+100] interval this would be a strong indicator

for only short-term improvement.

The hypothesis of my research is that similar to the U.S. also in Germany

hedge funds are associated with positive abnormal returns of target firm’s shares.

Since other research has shown that, unlike common believe, hedge funds are not

short term investors (Bratton and Williams, 2006), my hypothesis is that abnormal

returns of shares associated with hedge funds are not reversed in subsequent

periods.

Proof of this hypothesis would be linked to quantitative analysis showing

significant (95% confidence level) abnormal returns of target firm’s shares over a

[-10, +30] as well as a [-10, +60] interval. The [-10, +30] interval is most relevant to

identify abnormal returns after hedge fund activity become publicly known.

If an abnormal return over the [-10, +60] interval is lower than over the

[-10,+30] period then that is an indicator that the abnormal return is short-term

only and not based on real fundamental improvement.

Finally, an abnormal return over the [-10, +30] interval without any

abnormal return over a [-30,+30] period would indicate that the target firm’s share

took a dip before the hedge fund invested and that the hedge fund is only a free

rider exploiting the situation.

Why a significant abnormal return over the [-10,+30] period alone does not

sufficiently prove my hypothesis is best illustrated with the three below diagrams.

Only the first diagram shows a real share price improvement attributable to the

hedge fund. The other two examples show short-term improvement only and the

free rider example where there is an increase in the share price but not caused by

25

the hedge fund. Rather, the hedge fund is acting opportunistically, speculating

that after a dip the share price will recover.

Figure 2 - Real performance improvement

A real improvement to the underlying fundamentals of a share would result

in a rising share price without subsequent reversal. The improvement is resulting

in an above average rise and thereafter the share performance “normally”. This is

shown in Figure 2 above.

Figure 3 - Short-term speculative spike

If the share price increase is only short-term, meaning there is no real change

to the firm’s performance then the initial jump in the share price is expected to

reverse in a subsequent period. This is shown in Figure 3 above.

90

95

100

105

110

115

-90 -60 -30 0 +30 +60 +90

Hedge Fund

Markt

90

95

100

105

110

115

-90 -60 -30 0 +30 +60 +90

Hedge Fund

Markt

26

Figure 4 - Free rider

Lastly, not all share price movements are triggered by the activist hedge

fund. In fact, most share price changes have other reasons. It might therefore be

likely that a share performs above the market over the [-10, +30] period but only

because there was a short-term downwards dip which reversed shortly after.

Should a hedge fund buy during that dip, then the analysis would show a positive

abnormal return, however, this is not causally linked to the hedge fund. Figure 4

above is an example and a visual analysis of the share price performance as well

as referring to a longer term interval [-30, +60] can help identify and isolate such

cases.

My analysis of 46 occasions of hedge fund activism shows a result which is

utterly different from those in the U.S. Shares of target firms outperform the

market index only by 2.2% on average (buy-and-hold return over the [-10, +30]

period). The median value for the same period is even only 1.3%. This

performance is statistically not significantly different from the market index at a

95% confidence level. During the whole observation period (01/2004 until

07/2007) the DAX index had an average 40 day (equivalent to the [-10, +30]

interval) return of 2.2% (median 2.8%) while the target firm’s shares over the [-10,

+30] period achieved 4.8% (mean) and 3.8% (median). However, the standard

error for the sample was 0.023 (or 2.3 percentage points) and the difference

therefore is not statistically significant.

Over longer periods [-10, +60] the target shares buy-and-hold return is

equivalent to the market (mean 0%, median 0.1%) and over the even longer

80

85

90

95

100

105

110

-90 -60 -30 0 +30 +60 +90

Hedge Fund

Markt

27

[-100,+100] period target shares even under perform against the market with

negative abnormal return of -0.1% (mean) and -6.2% median.

The hedge funds target share performance against industry peers equally is

not significantly different. Abnormal returns are only 1.3% (mean) and negative -

0.5% (median) over the [-10, +30] interval with abnormal returns ranging from

negative -2.6% to 1.5% over the longer intervals.

The overall results are presented in Table 1 (abnormal return against market

index) and Table 2 (abnormal return against peer group) below.

(-10,30) (-30,30) (-10,60) (-100,100)

Average 2.2% 2.6% 0.0% -0.1%

Median 1.3% 1.0% 0.1% -6.2%

25th percentile -5.5% -5.6% -7.3% -13.2%

50th percentile 1.3% 1.0% 0.1% -6.2%

75th percentile 7.1% 10.0% 9.2% 15.8%

Standard Error 0.023186 0.025416 0.028297 0.040973678 Table 1 - Abnormal return against market index

(-10,30) (-30,30) (-10,60) (-100,100)

Average 1.3% 1.6% -1.3% -2.6%

Median -0.5% 1.6% 1.5% -1.0%

25th percentile -6.5% -8.6% -10.9% -22.6%

50th percentile -0.5% 1.6% 1.5% -1.0%

75th percentile 7.0% 8.5% 8.9% 19.7%

Standard Error 0.02291 0.025014 0.02805 0.039742334 Table 2 - Abnormal returns against peer group

At the 75% percentile target firm’s shares perform well and significantly

outperform the market and peer group. Here I also want to highlight that

abnormal returns are increasing over longer periods. This is a strong indication

that while many times hedge funds fail, in same cases they actually do achieve to

deliver sustainable long term improvements to overall operating performance.

Figure 5 and Figure 6 show the share price for EM.TV AG and SGL Carbon AG

over a six months period around hedge fund activism. The three vertical lines

mark the start, middle and end of the [-10, +30] interval. The most left line marks

t-10, the middle one t-0 and the right one t+30. The two straight lines between the

-10 and +30 markers are the projected market and peer performance as projected

from t-10. If the share price is above these lines then the share is delivering

28

positive abnormal returns and if the share price is below these lines then it is

delivering negative abnormal returns.

Figures 5 and 6 are examples of hedge fund activism associated with

positive abnormal returns without reversal in subsequent periods.

Figure 5 – Successful activism: EM.TV AG

Figure 6 – Successful activism: SGL Carbon AG

Figure 7 below illustrates the opposite case where hedge fund activism

backfired and was ill perceived by the market as the result of which the share

price dropped substantially by 17%.

2

2.5

3

3.5

4

8

9

10

11

12

13

29

Figure 7 – Failed activism example: KUKA AG

In chapter 3.4 on page 15pp. I have given the example of a rise of the share

price of Deutsche Post merely based on rumours that a hedge fund bought a 3%

stake. Figure 8 shows the share price performance around this date. This figure is

a wonderful example for two reasons. First, it correlates nicely to Figure 3 on page

25 and to the theory behind the graph which I presented earlier. There is a short

spike going up from € 22.85 on 24/4/2007 to € 25.63 on 27/4/2007. This spike is a

12% rise in just three days. Shortly thereafter the price falls back to €23.4. This is a

typical example for a speculative share prince increase which is not underlined by

any changes to the underlying fundamentals. Secondly, this graph also illustrates

that the sharp share price rise started a few days before day 0, the day of the

official announcement. This strongly indicates that information was leaked to the

market. Such leakage is the reason why for analysis I am using the [-10, +30]

interval instead of a [0, +30] interval. Using the latter would lead to wrong

conclusions as can be seen from the graph in Figure 8.

14

16

18

20

22

24

30

Figure 8 - Short term spike: Deutsche Post AG

Similarly, Figure 9 correlates well to Figure 4 on page 26 which I used to

illustrate the free rider strategy. There’s a downward dip in the share price of

Medion AG upon which the hedge fund reacts by increasing its stake to 10%,

speculating that the share price would recover, which it did. While such case

would show up as a significant abnormal return over the [-10, +30] period, it is

highly unlikely that the hedge fund helped improving Medion’s performance. Yet,

this does not mean that the price increase is not related to the hedge funds action.

Its move to increase its stake in Medion to 10% could very well have triggered

other investors and analysts to review their valuations. Maybe in fact Medion was

undervalued, the hedge fund spotted this and other investors followed. The cause

and effect relationship in this case is hard to identify but it seems likely that there

is an association between the price increase and the hedge fund action.

Figure 9 - Free rider example: Medion AG

21

22

23

24

25

26

27

9

10

11

12

13

14

31

The above example could be described as an event driven strategy; the

hedge fund responded to the temporary share price decline. Figure 10 is another

example of even driven strategy. In this example Rinol AG was in financial

distress. Around the date of hedge fund action two major events took place.

Firstly, there was a shareholder meeting at which shareholders approved the

presented turnaround strategy and secondly, banks granted additional loans to

Rinol AG. The share price increase is primarily attributable to the recovery of

Rinol, shareholders agreeing to the turnaround plan and banks granting

additional financing. The hedge fund was only a passive speculator in this case

(maybe having insider information).

Figure 10 - Event driven (distress) Example: Rinol AG

Another illustration of an event driven strategy is shown in Figure 11 below.

In this event Schering AG was a takeover candidate and bids by the acquirer were

already made (hence the sharp share price increase before the hedge fund action).

The involved hedge fund was speculating for an even higher bid by the acquirer

which in the end was successful but only marginally.

4

5

6

7

8

9

32

Figure 11 - Merger arbitrage example: Schering AG

Finally, there are also cases where even active activism by a hedge fund has

virtually no impact at all on the share price. Figure 12 is such a case. Techem AG’s

share price was flat while the market and peers were growing at normal rates.

This can be explained by the fact that the share price had already gone up

significantly from around € 38 to € 56. While the hedge fund claimed that the

company was underperforming and that the share price needed to rise, the market

had a different view and the hedge fund activism was not successful.

Figure 12 - No market reaction: Techem AG

Only in 15 out of 46 cases (33%) there was a significant (>5%) positive abnormal

return over the [-10, +30] observation period. In 5 out of these 15 occurrences the

positive abnormal return was reversed in subsequent periods. Out of the 10

remaining cases for two the rise in the share price appears to be attributable to

49

59

69

79

89

99

34

39

44

49

54

59

33

external factors (e.g. relieve of the distress situation in the case of Rinol AG). This

means that there are only 8 out of 46 cases where hedge funds had a long lasting

positive influence on the target firm’s share price. Even for the 8 remaining cases,

there is no clear evidence that the hedge funds are the source of the share price

increase. It is equally possible that hedge funds were just stock picking the right

shares at that time (8 out of 46 could be pure luck).

The mean abnormal return of the whole sample is only 2.2% measured

against the market index and 1.3% when measured against peer groups, and both

values are not significantly different from 0% at a 95% confidence level. Overall,

there is therefore little to no evidence that hedge funds are a source for share price

increases or real improvements of the target firm’s performance (which should be

reflected in the share price) as I had originally anticipated.

My findings give no proof of lasting share price improvements attributable

to hedge funds. These results imply that, unlike in the U.S., hedge funds in

Germany are unable to facilitate any kind of change that would result in real

improvements of underlying fundamental performance criteria which would

increase the value of the target firm. My findings also differ from the findings of

Brav et al. (2006), Klein et al. (2006) and Boyson et al. (2007) in the U.S. who all

found evidence of positive abnormal return attributable to activist hedge funds. A

simple explanation for this would be that my sample size was much smaller than

those of the U.S. studies, but I don’t believe that this is the real reason. It seems

more likely that market differences are the real reason behind the different

findings.

Roddy Campbell in his book “European event and arbitrage investing”

stipulated several laws of which the first law reads: “arbitrage has never worked in

countries that have never been ruled by Britain” (Campbell, 2003). He explicitly

includes most European countries, including Germany in the list of countries

never ruled by Britain. The truth behind this is indeed that financial markets in

Britain and in the U.S. have a different tradition than for example in Germany or

in Japan. Corporate funding in the U.S. has always been based on equity whereas

debt was (and in many cases still is) the main source of funding for firms in

34

Germany (Brealey, Myers, Allen, 2006). Consequently, the U.S. has a much

stronger sense for corporate governance and shareholder value and even

shareholder activism has a long history. In contrast, in Germany managers,

especially in smaller companies, are much less used to the idea of shareholder

value and stakeholder value is much more common. This can be attributed to the

fact that Germany puts a much stronger emphasis on co-determination which

weakens the influence that shareholders have. Shareholder activism is therefore

more difficult and rather uncommon as the shareholders are only one part of a

long list of stakeholders. The first obstacle for activist hedge funds is therefore to

get the firm’s management to listen. There are prominent examples in Germany

where hedge funds were successful (e.g. Deutsche Börse) but there are also other

prominent cases were the target firm’s management just ignored whatever the

hedge funds were demanding (e.g. CeWe). Even if the firm’s management buys in

to the hedge funds ideas, this doesn’t mean that the rest of the market will

appreciate such involvement. Ever since Franz Müntefering, former German

Federal Minister of Labour and Social Affairs called hedge funds locusts, are

investors scared that a hedge funds involvement could actually lead to poorer

long-term performance. Such anxiety can lead scared investors to sell their shares

upon receiving information that a hedge fund is planning to exert influence on a

firm. While I don’t have evidence for my theory, I do believe that differences in

the financial market and in corporate governance are the reason why hedge funds

in Germany are less successful than in the U.S. in regards to increasing target

firm’s share prices.

My research has primarily focused at long-term improvements of share

prices and I have only briefly touched upon the short term effects. I have given an

example of Deutsche Post AG were there was a very short-term spike in the price

of the share but I could only do so because information about this event was in the

news. I am certain that there are many cases were hedge funds are manipulating

share prices by small percentages over a very short period of time. Jim Cramer, a

former hedge fund manager has recently hinted to such practices in an interview

with TheStreet.com (New York Times, 2007), indicating that hedge funds could

manipulate share prices to go up or down as needed. The SEC has also recently

announced that it finds a large amount of suspicious trading, indicating insider

35

deals (SEC, 2006). John Coffee believes that hedge funds are the reason behind the

increase in insider trading. He states that “hedge funds are unregulated, and their

managers are not monitored as closely by compliance officers and counsel […]. Because

they trade in larger increments than more diversified institutional investors, they will pay

more for useful tips”. (Bingham McCutchen, 2006). While both sources are referring

to the U.S. market I suspect that also in Germany hedge funds are actively

involved in such manipulation. I dare to say that in some cases (e.g. Deutsche Post

AG), hedge funds pretend to be activist funds to make the market believe that

they will add value to the target’s share in order to benefit from a short-term price

increase. By the time the share price has fallen again, the hedge fund will have

sold its stake already, taking with it a small but profitable 1% or 2% gain.

Unfortunately, it is very hard to prove such suspicions due to the fact that hedge

funds are not regulated. As long as their stake remains below the 3% threshold at

which they would have to report their stake to the BaFin, hedge funds can trade

anonymously and only go public if it suits their need, e.g. they can buy a 2.8%

stake, announce this fact, wait for the price to rise and then sell their stake in

silence. Since hedge funds don’t have to report their dealings it is almost

impossible to get the necessary data to substantiate suspicions such as the one that

I have raised.

However, overall I can conclude that hedge funds in Germany have a

weaker position than they have in the U.S. Their impact on the market is felt much

less and their ability to drive corporate change is limited by German

management’s stance on shareholder value and corporate governance. And while

there are a few well publicized hedge fund related events, most hedge fund deals

in Germany go unnoticed and seem to be market neutral.

36

Allaire, Yvan and Firsirotu, Mihaela E., 2007, “Hedge Funds as Activist Shareholders: Passing Phenomenon or Grave-Diggers of Public Corporations?‖. Available at SSRN: http://ssrn.com/abstract=961828

Atzler, Elisabeth, 2005a, “Hedge-Fonds fordern Unternehmen heraus”, Financial Times Deutschland, 5 September, 2005

Atzler, Elisabeth,2005b, “Hedge-Fonds machen Tempo an den Börsen“, Financial Times Deutschland, 8 September, 2005

Barber, Brad M., 2006, “Monitoring the Monitor: Evaluating CalPERS' Shareholder Activism”, Working Paper.

Bingham McCutchen LLP, 2006, “Hedge Funds Newsletter”, Bingham McCutchen LLP, Fall 2006

Boyson, Nicole M. and Mooradian, Robert M., 2007, “Hedge Funds as Shareholder Activists from 1994-2005‖. Available at SSRN: http://ssrn.com/abstract=992739

Bratton, William W., 2006, “Hedge Funds and Governance Targets”, Available at SSRN: http://ssrn.com/abstract=928689

Braun, Christian, 2007, “Smoke, mirrors and Hedge Funds”, Ethical Corporation, July 7, 2007, http://www.ethicalcorp.com/content.asp?ContentID=5231

Brav, Alon, Jiang, Wei, Partnoy, Frank and Thomas, Randall S., 2006, “Hedge Fund Activism, Corporate Governance, and Firm Performance‖. ECGI - Finance Working Paper No. 139/2006 Available at SSRN: http://ssrn.com/abstract=948907

Brealey, Richard A., Myers, Stewart C., Allen, Franklin, 2006, “Corporate Finance”, 8th Edition, McGraw-Hill

Briggs, Thomas W., 2007, “Corporate Governance and the New Hedge Fund Activism: An Empirical Analysis”. Journal of Corporation Law, Vol. 32, No. 4, 2007 Available at SSRN: http://ssrn.com/abstract=911072

Campbell, Roddy, 2003, “European event and arbitrage investing”, as part of “Evaluating and Implementing Hedge Fund Strategies”, 3rd Edition, Euromoney Books

Campos, Roel C., SEC Commissioner, Speech to the Managed Funds Association, July 12, 2005

Chany, Nicholas T., Getmansky, Mila, Haas, Shane M. and Lo, Andrew W., 2005, “Systemic Risk and Hedge Funds‖. MIT Sloan Research Paper No. 4535-05 Available at SSRN: http://ssrn.com/abstract=671443

Clifford, Christopher, 2006, “Value Creation or Destruction? Hedge Funds as Shareholder Activists‖, Available at SSRN: http://ssrn.com/abstract=971018

Cox, Christoper, 2006, Testimony concerning the regulation of hedge funds (before the U.S. Senate Committee on Banking, Housing and Urban Affairs), July 25 2006, Available at: http://www.sec.gov/news/testimony/2006/ts072506cc.htm

37

Dougherty, Carter, 2007, “Economic power to study growing influence of hedge funds”, International Herald Tribune, February 10, 2007, available at: http://www.iht.com/articles/2007/02/10/europe/web.0210G7.php

Financial Times, 2005, “Hedge funds hold a quarter of Germany's blue-chips”, Financial Times, 2 September, 2005

Financial Times Deutschland, 2005, “Hedge-Fonds machen Tempo an den Börsen“, Financial Times Deutschland, 8 September, 2005

Fisher, Kenneth L., Statman, Meir, 2002, “Blowing Bubbles”, The Journal of Psychology and Financial Markets, 2002, Vol. 3, No. 1, Pages 53-65

Gabelli, Mario J., 2007, “The History of Hedge Funds – The Millionaire’s Club”, GAMCO Investors Inc., retrieved on August 1, 2007. Available at: http://www.gabelli.com/news/mario-hedge_102500.html

Garbaravicius, Thomas, Dierick, Frank, 2005, “Hedge Funds and Their Implications for Financial Stability”, European Central Bank, Occasional Paper Series, No. 34, August 2005

Gillan, Stuart L. and Starks, Laura T., 2007, “The Evolution of Shareholder Activism in the United States”. Available at SSRN: http://ssrn.com/abstract=959670

Goetzmann, William N., and Stephen A. Ross, 2000, “Hedge funds: Theory and performance”, Working Paper, Yale University and Massachusetts Institute of Technology

Hu, Henry T.C. and Black, Bernard S., 2007, “Hedge Funds, Insiders, and the Decoupling of Economic and Voting Ownership: Empty Voting and Hidden (Morphable) Ownership‖. Journal of Corporate Finance, vol. 13, pp. 343-367, 2007 Available at SSRN: http://ssrn.com/abstract=874098

Hu, Henry T.C., and Black, Bernard, 2006, “Hedge funds, insiders, and empty voting: Decoupling of economic and voting ownership in public companies”, Working paper, University of Texas Law School

International Financial Law Review, 2005, “Germany to reward active shareholders”, International Financial Law Review; Nov2005, Vol. 24 Issue 11, p10-10, 2/3p

Jensen, Michael C., 1986, Agency costs of free cash flow, corporate finance, and takeovers, “American Economic Association Papers and Proceedings‖, May 1986, pp. 323-329.

Kahan, Marcel and Edward Rock, 2006, “Hedge Funds in Corporate Governance and Corporate Control”, New York University working paper.

Karpoff, Jonathan M., 2001, “The Impact of Shareholder Activism on Target Companies: A Survey of Empirical Findings”, Working Paper.

Kahn, Charles, and Andrew Winton, 1998, “Ownership Structure, Speculation, and Shareholder Intervention”, Journal of Finance 53, 99-129.

38

Klein, April and Zur, Emanuel, 2006, “Hedge Fund Activism”, AAA 2007 Financial Accounting & Reporting Section (FARS) Meeting Paper Available at SSRN: http://ssrn.com/abstract=913362

Kiev, A., 2002, “The psychology of risk mastering market uncertainty”, New York, NY, John Wiley & Sons

Lake, Ronald A., 2003, “Evaluating and Implementing Hedge Fund Strategies”, 3rd Edition, Euromoney Books

McWhinney, Jim, 2005, “A Brief History of the Hedge Fund”, Investopedia, November 8, 2005, Available at http://www.investopedia.com/articles/mutualfund/05/HedgeFundHist.asp

New York Times, 2007, “Jim Cramer’s Guide to Market Manipulation”, DealBook, New York Times, March 20, 2007, available at: http://dealbook.blogs.nytimes.com/2007/03/20/cramer-market-manipulator/

Odland, Steve, 2006, Keynote address to the National Association of Corporate Directors, October 16 2006, available at: http://www.businessroundtable.org/taskForces/taskforce/document.aspx?qs=7085BF159F949514481138A77EC1851159169FEB56A36B9AE

Reuters, 2007, “Deutsche Post up on talk of TCI stake build”, Stock New Europe, Reuters, June 14, 2007

Rose-Smith, Imogen, 2006, “The Hedge Fund 100”, Institutional Investor’s Alpha, Alpha Research Centre, June 2006

Schiller, Ben, 2006, “Hedge funds and private equity - Trading down corporate responsibility”, Ethical Corporation, November 14, 2006. http://www.ethicalcorp.com/content.asp?ContentID=4681

SEC, 2006, Testimony of Linda Chatman Thomson, Director Division of Enforcement U.S. Securities and Exchange Commission, SEC, December 5, 2006, available at: http://www.sec.gov/news/testimony/2006/ts120506lct.pdf

Shiller, Robert J., 2000, “Irrational Exuberance”, Princeton, N.J.: Princeton University Press, 2000

Süddeutsche Zeitung, 2007, “Finanzinvestoren”, Süddeutsche Zeitung, 29 June, 2007

39

Target Hedge Fund Day 0 Comments

10tacle Avenue Capital 13/10/2006 stake increased to above 8%

Balda Guy Wyser-Pratte 17/01/2007 increased stake to 5.39%

Bertrandt Absolute Capital Management 28/12/2005 stake REDUCED from 6.5% to 3.7%

BHW Absolute Capital Management 23/12/2005 3% stake

Borussia Dortmund Och-Ziff 27/06/2006 7.56%

CeWe MarCap (M2 Capital) 31/01/2007 has 9%; demands extraordinary dividend

Commerzbank Tosca Fund 03/08/2005 also Lansdowne; merger arbitrage (hoping for takeover)

Deutsche Börse Atticus 24/02/2007 pressure to make changes and increase dividend

Deutsche Börse TCI 09/05/2006 10% stake

Deutsche Post TCI 27/04/2007 speculation that TCI would invest

Deutsche Telekom Laxey 03/11/2006 Activism starts here

Deutsche Telekom Blackstone 24/04/2006 4,5%

Drillisch Montrica 09/03/2007 6.17%

EM.TV Centaurus 11/10/2004 5.22% stake reported

EM.TV MarCap (M2 Capital) 09/06/2007 3% stake

Evotec Absolute Capital Management 02/07/2007 3.037%

Freenet Hermes 25/06/2007 Hermes (holding 5.2%) pushing for divestment, support from ACM

Freenet Absolute Capital Management 24/05/2007

bought 3% and announced planned increase to 5% and expectation of 6Euro dividend

Gerry Weber Absolute Capital Management 22/02/2007 3.3% stake

Heidelberger Druck Centaurus 04/07/2007 5.13%

Hugo Boss (Valentino) Carlyle 16/05/2007

Carlyle and Permirar want to takeover Valentino

Karstadt Wellington Management Company 01/03/2007 KUKA (IWKA) Guy Wyser-Pratte 28/10/2003 buys 5% stake

KUKA (IWKA) Guy Wyser-Pratte 17/10/2005 stake increased to 7%

KUKA (IWKA) K Capital Partners 07/05/2005 5.29% stake

Medion Orbis 24/01/2005 5.5% stake

Medion Orbis 21/01/2006 stake increased to 10% (early January)

Mistral Media AG Absolute Capital Management 22/12/2006 Pixelpark AG Absolute Capital Management 29/03/2007 Praktiker Eton Park Capital Management 13/04/2006 stake 6.6%

Praktiker T. Rowe Price 10/05/2006 second hedge fund to invest, stake 5.24%

Praktiker Eton Park Capital Management 03/07/2006 stake REDUCED from 6.6% to 2.4%

Rinol Highbride 10/08/2005 Highbride plans to TAKE OVER Rinol (who is in distress situation)

Schering Citadel 12/04/2006

77 euro bid on march 13 2006, price jump already before HF announcement due to bid, latest bid 86

SGL Carbon K Capital Partners 19/05/2005 K Capital and others have bought 15% stake (total, all three)

SGL Carbon K Capital Partners 24/06/2005 stake REDUCED to 2.8%

TAG Tegernsee Absolute Capital Management 18/08/2006 stake 5%

TAG Tegernsee Taube Hodson Stonex 07/09/2006 11% stake

40

Techem Elliot Associates 15/03/2007 stake increased to above 10% and to 15% one week later

Techem Elliot Associates 03/01/2007

first report 3 Jan; further activism mid March 2007 and June 26 2007; quadrupled dividend announced Feb 2007

TUI Absolute Capital Management 12/03/2007 3% over last 2-3 months

TUI various 13/08/2004 various hedge funds SHOWING INTEREST, not actually buying

Vivacon Absolute Capital Management 02/03/2007 3% stake since February 21

41

42

10

10.5

11

11.5

12

12.5

13

13.5

14

14.5

1510tacle

4

5

6

7

8

9

10

11

12Balda

7

8

9

10

11

12

13

14Bertrandt

43

1.7

1.9

2.1

2.3

2.5

2.7 Borussia Dortmund

29

34

39

44

49 CeWe

14

16

18

20

22

24 Commerzbank

44

42

47

52

57

62

67 Deutsche Börse

55

60

65

70

75

80

85

90

95 DeutscheBörse (2)

19

20

21

22

23

24

25

26

27

28Deutsche Post

45

10

11

12

13

14

15

16Deutsche Telekom

11

11.5

12

12.5

13

13.5

14

14.5

15

15.5

16Deutsche Telekom (2)

41

46

51

56

61

66

71

76

81 DIS

46

5

5.5

6

6.5

7

7.5

8

8.5

9

9.5

10Drillisch

2

2.2

2.4

2.6

2.8

3

3.2

3.4

3.6

3.8

4EM.TV

4

4.1

4.2

4.3

4.4

4.5

4.6

4.7

4.8

4.9

5EM.TV (2)

47

15

17

19

21

23

25

27 Freenet

15

17

19

21

23

25

27 Freenet (2)

14

16

18

20

22

24 Gerry Weber

48

34

39

44

49

54

59 Hugo Boss

14

15

16

17

18

19

20

21

22

23

24KuKa

15

16

17

18

19

20

21

22

23

24

25KuKa (2)

49

17

19

21

23

25

27

29

31 Karstadt

10

11

12

13

14

15

16

17

18

19Medion

9

9.5

10

10.5

11

11.5

12

12.5

13

13.5

14Medion (2)

50

1

2

3

4

5

6

7

8

9Nordex

18

20

22

24

26

28 Praktiker

18

20

22

24

26

28 Praktiker (2)

51

15

17

19

21

23

25

27

29Praktiker (3)

4

4.5

5

5.5

6

6.5

7

7.5

8

8.5

9Rinol

49

59

69

79

89

99 Schering

52

8

8.5

9

9.5

10

10.5

11

11.5

12

12.5

13SGL

8

9

10

11

12

13

14SGL (2)

7

7.5

8

8.5

9

9.5

10

10.5

11TAG

53

7

7.5

8

8.5

9

9.5

10

10.5

11TAG (2)

34

39

44

49

54

59Techem

46

48

50

52

54

56

58

60

62 Techem (2)

54

11

12

13

14

15

16

17

18TUI

14

15

16

17

18

19

20

21

22

23

24TUI (2)

18

20

22

24

26

28

30

32

34Vivacon

55

16

18

20

22

24

26

28

30 Arquana

3

3.5

4

4.5

5

5.5

6Mistral

1

1.1

1.2

1.3

1.4

1.5

1.6

1.7

1.8

1.9

2Pixelpark

56

0.8

0.9

1

1.1

1.2

1.3

1.4

1.5WCM

13

13.5

14

14.5

15

15.5

16

16.5

17

17.5

18BHW

57

Relevant hedge funds and search terms used for the database research:

3I DEUTSCHLAND GMBH 3i Group Investments 3i Group Aberdeen Asset Management Asia Aberdeen Asset Management Co Aberdeen Asset Management Aberdeen Asset Managers Growth Capital Aberdeen Asset Managers Private Equity Aberdeen High Income Trust Aberdeen Murray Johnstone Private Equity Aberdeen Preferred Income Trust Aberdeen Preferred Securities Aberdeen Private Investors Aberdeen Private Investors -Investment Management Business Aberdeen Property Investors AS Aberdeen Property Investors Nordic AB Aberdeen Property Investors Services Aberdeen Property Investors UK Aberdeen Real Estate Fund Finland Aberdeen Trust Holdings Absolute Capital Management Absolute Capital Management Holdings Accipiter Capital Management Affinity Equity Partners Affinity Equity Partners AHL AIM Trimark Angelo Gordon Angelo Gordon & Co Antilooppi Oy Appaloosa Management Appaloosa Mgmt AQR Capital Asset Value Investors Atticus Capital Atticus Capital Atticus Global Fund Atticus Investments Assets Inc Atticus Management Atticus Mauritius August Broetje GmbH Avenue Capital Avenue Capital Group Barclays Global Investors Barington Capital Group BC European Capital

BC Partner GmbH BC Partners Holding BC Partners Bessent Capital BIG-Heimbau AG Blackstone Blackstone Capital Partners IV Blackstone Capital Partners Blackstone Capital Partners V Blackstone Group International Blackstone Group International Blackstone Group Blue Ridge Capital Blue Wave BlueBay Asset Management BlueCrest Capital BlueMountain Boussard & Gavaudan Boussard & Gavaudan Gestion Boussard & Gavaudan Holding BP Capital Management Bradesco Asset Management a Brevan Howard Bridgewater Bridgewater Associates Inc. Brummer & Partners Buchanan Capital Holding AG Buchanan Capital Management Buchanan Capital Partners GmbH Bulldog Investors Bulldog Investors General Partnership Burton Capital BV Burton Capital Managament Burton Capital Management / BCM Callahan Associates International Callahan Associates Intl CambridgePlace Investment Management Cannell Capital Cantillion Capital Management Cantillon Capital Growth Financial Capital Growth Fund Capital Growth Partners Capital Management Advisors Group Cardinal Value Equity Partners Carl Icahn Carlos Slim Helu

58

Carlyle Group Caxton Associates Celanese AG Celanese Europe Holding GmbH Celanese Europe Holding GmbH & Co KG Celexa Group Centaurus Capital Centaurus Capital Centaurus Energy Cerberus Capital Cerberus Capital Management Cerberus European Investments Cerberus Investment Cevian Capital CeWe Color Holding AG CGA Insurance Brokers Chap-Cap Activist Partners Chap-Cap Partners 2 Chapman Capital Cheyne Capital Cheyne Capital Management Children's Invest Fund Mgmt Children's Investment Fund Management Children's Investment Fund Mgmt Cholet Acquisitions Citadel Citadel Investment Group Clarium Capital CMP Acquisition Corp CMP Group Inc CMP Holdings CMP Investments CMP Partners Coller Capital Convexity Copper Arch Capital Costa Brava Partnership III, CQS Cyrus Capital Partners D.E. Shaw David Jones DE Shaw Deutsche Annington Immobilien Deutsche Asset Mgmt Grp Diamond Hill Focus Long-Short Fund Dillon Read Dividend Capital Trust Inc Dolphin Dometic International AB Drive Sarl Dubai Financial

Dubai Holding Edward Lampert Egerton Capital Elliot and Deka Elliott Associates Elliott International Elliott Management Corp Enhanced Zero Trust EQMC Fund Equitilink elink ESL Investments ESL Investments Inc ESL Partners II ESL Partners Ethos Fund Eton Park Eton Park Capital Management Eurocastle Investment Everest Capital Advisors Exel Farallon Farallon Associates Farallon Capital Institutional Partners II Farallon Capital Institutional Partners III Farallon Capital Institutional Partners Farallon Capital Management Farallon Capital Management Farallon Capital Management Partners Farallon Capital Offshore Investors II Farallon Capital Offshore Investors Inc Ferox Capital Fortress Fortress Deutschland GmbH Fortress Investment Group FrontPoint Fulcrum Asset Management Gabelli Asset Management GAGFAH Immobilien-Management Gartmore GBH Acquisition GmbH Gerresheimer Group Glenview Capital GLG Partners Goldman Sachs Asset Management Goodwood Graham Investment Managers Grainger Trust Greenlight Capital Guy Wyser-Pratte Hao 63 Harold Simmons

59

Hastings Funds Management Heat Beteiligungs III GmbH Hennessee Group Hermitage Capital Corp Hermitage Capital Management HERMITAGE CAPITAL MANAGEMENT HIE Ventures Highbridge Highbridge Capital Highbridge Capital Management Highbridge Event Driven/ Relative Value Highbridge International Highfields Capital Highfields Capital GP Highfields Capital Management Highland Capital Corp Highland Capital Holding Corp Highland Capital Management Highland Capital Partners HL Income & Growth Trust Icahn Partners Icahn Partners Master Fund International Management Associates Investor Group Investor Group Investors Investors IXIS Capital Partners Jabre Capital Partners Jana Partners JP Morgan JTR Management JWM Partners K Capital Partners K Capital Pty Kailix Advisors KBC Alternative Investment Management Kingdon Capital Kynikos Lansdowne Partners Laxey Investment Trust Laxey Partners Legg Mason Liberation Investment Group Liverpool Liverpool Partnership London Diversified Fund Management Lone Pine Lone Pine Capital Longhirst Group Magnetar

Man Group Marcap Corp Marshall Wace Maverick Capital Millennium Partners Moneywise Queensland Pty Montrica Investment Management Moore Capital Murray Emerging Growth & Income Trust Murray Japan Growth & Income Murray Johnstone Holdings Murray Johnstone Murray Johnstone Private Equity Nakornthon Schroder Asset Management Co Northern Trust Corp Northern Venture Managers Oaktree Capital Group, Oaktree Capital Management Oaktree Capital Management. Och Ziff Capital Och-Ziff Och-Ziff Capital Management Group Och-Ziff Management Europe Octavian Advisors Omega Advisors Omega Advisors Inc Opportunity Partners Orbis AG Orbis Capital Orbis Investment Management Orbis Investment Management OSK Asia Securities Ospraie Management Owl Creek Asset Management Pardus Capital Mgmt Paulson & Co Pembridge Capital Management Pequot Capital Perry Capital Perry Capital Corp Perry Capital Group Perry Corp Pershing Square Capital Mgmt Pirate Capital Platinum Equity Polygon Investments Primemodern Prolific Financial Management PSAM Questor Partners Fund II RAB Capital

60

Red Kite Relational Investors Renaissance Technologies Richard Blum Richards Longstaff Rowe Price Fleming International Inc SAC Capital SAC Capital Advisors Sandell Asset Management Sandell Asset Management Corp Sandell Perkins Santa Monica Partners Scandinavian Property Development ASA Schultze Asset Mgmt Scottish National Trust Shepherd Investments International Silver Point Capital Silver Point Capital Fund Investments SkyBridge Capital Sloane Robinson Soros Fund Management Southeastern Asset Management Stark International Stark Trading Steel Partners Steel Partners II Steel Partners Stewart Horejsi SULO GmbH SULO Group SULO Nord-West GmbH & Co KG Sulo Ost GmbH & Co KG TCA Group TDC A/S Techem AG Techem AG Energy Contracting Techem Energy Services GmbH Terra Firma Capital Partners Terra Firma Capital Partners Terra Firma Capital Partners -Movie Houses

Terra Firma Investments Thames River Capital The Children’s Investment Fund Themis Investment Management Third Avenue Managment Third Point Third Point Partners Tibbet & Britten Deutschland Tontine Tosca Fund Toscafund Touradji Capital Touradji Capital Management TPG-Axon Tracinda Corp Trafelet & Co Trian Fund Management Trian Group Tribeca Tudor Tudor Arbitrage Partners Tudor Capital Partners Tudor Capital Ventures II Tudor Capital Tudor Group Holdings Tudor Investment Corp Turdor Investment Corp Undisclosed Danish Properties ValueAct Capital Management Vega Asset Management Viterra Energy Services AG Viterra Sicherheit und Service GmbH VMS Value Management Services Whitehall Street Fund WS Capital Wyser-Pratte York Capital

61

List of hedge fund managers and hedge fund investors which were used to

supplement the database search:

William Ackman Jeffrey Altman Richard Blum Robert Burton Robert Chapman Steve Cohen Michael Dell Ric Dillon Phillip Goldstein Charles Gradante Christopher Hohn Stewart Horejsi Tom Hudson Carl Icahn Kirk Kerkorian Edward Lampert Daniel Loeb Donald T. Netter Jim Mitarotonda Nelson Peltz Barry Rosenstein Michael Roth David Shaw Harold Simmons Scott Sipprelle Carlos Slim Helu Brian Stark David Tepper Ralph Whitworth Guy Wyser-Pratte

62

Convertible Arbitrage: This strategy is identified by hedge investing in the

convertible securities of a company. A typical investment is to be long the

convertible bond and short the common stock of the same company.

Positions are designed to generate profits from the fixed income security as

well as the short sale of stock, while protecting principal from market

moves.

Dedicated Shortseller: Dedicated short sellers were once a robust category

of hedge funds before the long bull market rendered the strategy difficult

to implement. A new category, short biased, has emerged. The strategy is

to maintain net short as opposed to pure short exposure. Short biased

managers take short positions in mostly equities and derivatives. The short

bias of a manager's portfolio must be constantly greater than zero to be

classified in this category.

Emerging Markets: This strategy involves equity or fixed income investing

in emerging markets around the world. Because many emerging markets

do not allow short selling, nor offer viable futures or other derivative

products with which to hedge, emerging market investing often employs a

long-only strategy.

Equity Market Neutral: This investment strategy is designed to exploit

equity market inefficiencies and usually involves being simultaneously

long and short matched equity portfolios of the same size within a country.

Market neutral portfolios are designed to be either beta or currency

neutral, or both. Well-designed portfolios typically control for industry,

sector, market capitalization, and other exposures. Leverage is often

applied to enhance returns.

Event Driven: This strategy is defined as `special situations' investing

designed to capture price movement generated by a significant pending

corporate event such as a merger, corporate restructuring, liquidation,

bankruptcy or reorganization. There are three popular sub-categories in

event-driven strategies: risk (merger) arbitrage, distressed/high yield

securities, and Regulation D.

Fixed Income Arbitrage: The fixed income arbitrageur aims to profit from

price anomalies between related interest rate securities. Most managers

trade globally with a goal of generating steady returns with low volatility.

This category includes interest rate swap arbitrage, U.S. and non-U.S.

government bond arbitrage, forward yield curve arbitrage, and mortgage-

backed securities arbitrage. The mortgage-backed market is primarily U.S.-

based, over-the-counter and particularly complex.

Global Macro: Global macro managers carry long and short positions in

any of the world's major capital or derivative markets. These positions

reflect their views on overall market direction as influenced by major

economic trends and/or events. The portfolios of these funds can include

stocks, bonds, currencies, and commodities in the form of cash or

63

derivatives instruments. Most funds invest globally in both developed and

emerging markets.

Long/Short Equity: This directional strategy involves equity-oriented

investing on both the long and short sides of the market. The objective is

not to be market neutral. Managers have the ability to shift from value to

growth, from small to medium to large capitalization stocks, and from a

net long position to a net short position. Managers may use futures and

options to hedge. The focus may be regional, such as long/short U.S. or

European equity, or sector specific, such as long and short technology or

healthcare stocks. Long/short equity funds tend to build and hold

portfolios that are substantially more concentrated than those of traditional

stock funds.

Managed Futures: This strategy invests in listed financial and commodity

futures markets and currency markets around the world. The managers are

usually referred to as Commodity Trading Advisors, or CTAs. Trading

disciplines are generally systematic or discretionary. Systematic traders

tend to use price and market specific information (often technical) to make

trading decisions, while discretionary managers use a judgmental

approach.

Multi-Strategy: The funds in this category are characterized by their ability

to dynamically allocate capital among strategies falling within several

traditional hedge fund disciplines. The use of many strategies, and the

ability to reallocate capital between them in response to market

opportunities, means that such funds are not easily assigned to any

traditional category. The Multi-Strategy category also includes funds

employing unique strategies that do not fall under any of the other

descriptions.

Fund of Funds: A `Multi Manager' fund will employ the services of two or

more trading advisors or Hedge Funds who will be allocated cash by the

Trading Manager to trade on behalf of the fund.