How Index Funds Help Activists Secretly Buy Blocks

Activist investor Andrew Shapiro is keeping a close eye on June 22.

That’s because the FTSE Russel is expected to rebalance its Russell 3000 index on or around that day and he sees it as a tremendous opportunity to accumulate a significant position in a potential target company.

“A lot of index funds go in and out that day. There is a massive inflow and outflow of funds since major transactions are basically mandated by many funds, and you will see a huge spike in trading,” Shapiro said. “It’s a great liquidity opportunity to accumulate large stakes in companies.”

Shapiro, who typically targets small and micro-capitalization companies with activist campaigns, said he would accumulate large stakes in corporations that are falling out of an index and consequently will be departing major index funds.

“When indexes punt them, index funds are required to sell them regardless of their fundamentals,” Shapiro said. “Natural candidates for companies to acquire are those being sold simply because they exit the index.”

Shapiro, who does a lot of fundamental analysis, points to what he calls the “incompetent methodology of market-weighted index funds” for making cheap and attractive investments “cheaper and more attractive.”

Accumulating large stakes in particularly illiquid small and micro-cap companies can be difficult for activists. For one thing, merely buying a 5% or 10% stake in a thinly traded security is difficult on its own. Also, accumulations of large positions typically drive the price up, making it hard for the activist to accumulate the stakes they need at affordable prices. However, purchases conducted during index rebalancing days reduce transaction costs by making it possible to buy large stakes without moving the needle on the company’s share price.

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