Moody's warns activist hedge funds make corporate bond ownership riskier

By Nicel Jane Avellana

Mar 11, 2014 06:05 AM EDT

In a research report, credit rating agency Moody's said there is now more risk in owning corporate bonds due to the increasing power of activist hedge funds, the Financial Times reported.

Moody's said a growing wave of "credit-negative events" could be encountered by bondholders this year due to the increased number of campaigns undertaken by activist investors against the managements of companies. The warning comes as activist hedge funds have earned handsomley by seeking firms that are undervalued in their view and then putting pressure on management to hold share repurchases and increase dividends, the report said.

Moody's Analyst Chris Plath, the author of the report, told FT, "Companies will take actions to please or ward off activists that leave them with less cash to pay off debt. There are more and more cases each year, and larger companies being targeted, and company boards and managements do not want to end up on the front page of the Financial Times for coming under attack from an activist."

According to Moody's data, North America posted 220 activist cases last year. This represented an increase from the 209 cases the year before that and the 179 cases in 2011. Hedge fund research firm eVestment said activist hedge funds now have $66 billion under management, as inflows and returns were robust last year, the report said.

While the technology sector poses the most risk of deteriorating its credit quality, activism is also spreading its imprint to other sectors. However, Moody's said that managements are most likely going to prevent the attack by taking actions that will benefit the shareholders, the report said.

Moody's said in the report, "Changes can include strategic and financial policy shifts, new or expanded share repurchases or divestitures of cash-generating assets where shareholders pocket the proceeds. Such manoeuvres can jeopardise cost-savings initiatives and lead to deterioration in credit metrics. In 2013, for example, ADT Corporation, BMC Software and Nuance Communications were all downgraded, in actions that were at least influenced by responses to activist pressure." 

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