The mutual fund that reads like a cheat sheet for activists

[October 15, 2014]  By Jessica Toonkel

For over seven years, fund managing partners Bob Olstein and Eric Heyman have had the good fortune of investing in a number of companies that were later bought out or became targets of big-name shareholder activists.

This year alone, their Olstein Strategic Opportunities Fund has seen two of its holdings targeted by activists and another six the object of announced acquisitions. That's a significant showing for a fund with a smallish $116 million portfolio.

Those kind of market events generally drive big gains in a stock's price, and the fund's ability to be there first has rewarded shareholders. Over three years its returns have been double those of the average activist hedge fund, making its portfolio one for bargain hunters to watch.

Heyman and Olstein, who ran his own stock research service in the 1960s, have a simple explanation for their success: it's all about the balance sheet.

“A lot of people look at these businesses and treat them as stocks,” Heyman said in an interview. “We look at it as if we are a private equity company and we are buying the business.”

Over the five years ended Sept. 30, outside activists like Jana Partners, Relational Investors and Nelson Peltz of Trian Partners have invested in nine of the companies that are among Olstein's portfolio holdings; none would comment for this story.

"We think there are some pretty smart people monitoring our portfolio," the 73-year-old Olstein told Reuters.

Heyman and Olstein look for small-cap companies that have stumbled but offer solid management, turnaround prospects and the ability to produce free cash flow.

Those metrics have brought them to companies like CareFusion, a top holding of the fund that recently agreed to be acquired by Becton Dickinson & Co in a deal that valued the company at a 26 percent premium to its last closing share price. In July, when hedge fund Jana Partners announced its activist stake in PetSmart Inc, the Olstein fund was already sitting on 69,000 shares, according to Lipper.

The fund also holds nutritional supplement retailer Vitamin Shoppe, which is the subject of shareholder and activist calls for a sale.

AN AVENUE FOR INDIVIDUAL INVESTORS

As of Sept. 30, the Olstein fund had a three-year annualized return of 26.48 percent, while the Activist Hedge Fund Index had an annualized return of 13.16 percent.

"For individual investors who cannot afford to invest with the hedge fund activists, this is a way to own shares of the companies many are targeting," said Todd Rosenbluth, director of mutual fund research at S&P Capital IQ.

The Olstein fund is expensive, with management fees of 1.60 percent, and certain share classes carry sales charges. It is, however, cheaper than activist hedge funds, which tend to charge management fees around 1.75 percent plus incentive fees.

The fund has not escaped this year's stock market selloff. It is down 2.24 percent through Oct. 10, compared with the 7.44 percent average decline for Lipper's category of small cap core funds.

There is one consumer fund that is solely focused on activists' targets, the 13D Activist Fund, but it buys companies after they have been targeted. The fund returned 0.71 percent this year through Oct. 10.

But for Olstein and Heyman, value is not defined by activists' interests. They still hold audio equipment maker Harman International Industries, five years after buying the stock and two years after it was targeted by Relational Investors.

Similarly, Heyman and Olstein are sticking with all-terrain vehicle maker Arctic Cat, which recently fired its chief executive officer. At roughly $32 a share, the stock is down 44 percent this year but Heyman and Olstein believe the company could become a $45 stock with a new CEO.

Olstein's process does not always work. In 2011, the fund was down 7.6 percent, compared with an average decline of 3.4 percent for small-cap core funds, according to Lipper.

Olstein and Heyman themselves have behaved like activists in only a handful of situations, usually behind the scenes, and said they never engage with hedge fund activists.

"I have no desire to be the next Carl Icahn," Olstein said. "Carl knows how to take over companies, I know how to value them."

(Reporting by Jessica Toonkel; Editing by Linda Stern and Leslie Adler)

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