Scrappy Activist Funds: Will They Win Fights for You?

Watching from the sidelines as Icahn and Ackman brawl over stocks? These funds let you in on the action.

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• Don't get involved when there is a "negative catalyst" who is taking a position, such as Ackman's short position in Herbalife (still, Squire considers the Pershing fund manager one of smartest investors).

• Invest in situations that include a "positive catalyst" who can "unlock hidden value" that company managers have avoided.

• Have a deep knowledge of the investor's track record in the sector in which they are investing.

• Ask in what way will the investor try to influence the company strategy, and does it have a realistic chance of success?

• Don't get involved in huge deals like Apple where a 5 percent stake is a large amount for activists to keep in place.

• Take positions that require 18 months or more to pay off in transforming an underperforming company.

The strong recent performance of activist investing has won followers because traditional hedge funds have been underperforming and value investors have been "whipsawed" in trying to find underpriced stocks to buy low and sell high, says another fund manager who tracks activists and hedge funds. The market's sharp ups and downs over the past few years have made value investing difficult.

"Events-driven investing does not follow the market movements as closely," says Maz Jadallah, head of AlphaClone, which runs a similar exchange-traded fund, AlphaClone Alternative, which follows hedge-fund manager investments and uses them in a long-short strategy that aims to even out fund performance. The fund has steadily risen to a 20 percent gain since it began trading last year. News Corp, Delphi Automotive, and Procter & Gamble are among its top holdings.

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The fund's largest holding is Apple, whose steep fall has put a lid on the returns of his fund. Jadallah thinks the activist interest of investor David Einhorn in Apple "may or may not be positive." Only time while tell, he says.

Einhorn sued Apple to push for better use of its huge cash pile for shareholders, but recently dropped a lawsuit pushing it to act. Jadallah says he sees the company recovering because it has "seamless and delightful products over a wide range of categories" and has unfairly "been reduced to being just a mobile company falling behind."

The reason to follow activists and hedge fund managers like Einhorn, however, is not that they are always right but "when you invest in them, you are getting the best investment minds in the world," Jadallah says. And some of the scrappiest.