In theory, a bear market should be a godsend for activist investing. When share prices fall, shareholders, board members, senior managers and other stakeholders are likely to be more receptive than they might otherwise be to external suggestions and plans for creating the kind of value that can get a company’s stock moving in an upward direction.

However, a recent New York Times commentary argues otherwise. The author, University of California-Berkeley professor Steven Davidoff Solomon, writes that falling share prices have “hit activist hedge funds particularly hard, raising the question of whether shareholder activism can survive a market downturn.” An influx of new players, a willingness to make riskier bets than in the past, greater portfolio concentration, and “herding” among activist funds set the stage for significant losses when the post-crisis uptrend began to falter.

In Solomon’s view, “the degree of concentration is one reason 2015 was an annus horribilis for many big hedge funds. Last year, Pershing Square lost 20.5%, Jana was down 5.4%, and Greenlight Capital fell 20%. Even Mr. Icahn, who does not announce results, most likely lost a fair amount of money. This was even before the market downturn in January.”

Heightened risk-taking

But such practices are, in fact, reflective of a broader trend during an era of ultra-low rates and policymaking that encouraged imprudent behavior. Whether in equity, fixed-income or other markets, or among hedge funds, long-only managers or individual investors, there has until recently been widespread interest in strategies that benefit in some way from leverage, illiquidity, momentum and other factors that can augment performance in a potentially risky manner.

Certainly, no one should have been surprised by this. When the returns available from traditional approaches are inadequare, economic conditions are less than robust, correlations within and across asset classes are high, dispersion among securities is low, and central bankers offer repeated assurances that there won’t be any nasty surprises, most rationale investors, including activists, would naturally feel compelled to follow the crowd and disavow the more cautious perspectives that prevailed in earlier, more normal times.

Ironically, the fact that hedge fund activism was one of the better performing strategies of the past several years probably heightened the odds that the sector would be infected by the epidemic of excessive risk-taking that easy money fostered. Over the past four years, for example, the HFRI activist index rose by 1.5%, 4.8%, 16% and 21%, respectively, outpacing the broader HFRI fund-weighted composite index by a healthy margin.

Performance of Activist Hedge Funds

The search for performance

But does this mean that activism per se is set for some sort of comeuppance, as Mr. Solomon suggests? It hasn’t only been this sector that has seen an influx of capital, though the recent pace of inflows is impressive by most measures. But as researcher Preqin notes, alternative asset managers’ increased assets under management by $500 billion to a record $7.4 trillion in 2015, suggesting that investors have been seeking higher returns from a variety of such strategies.

Activist Funds Under Management

Arguably, one reason why activism has attracted so much interest from investors and other fund managers is because it is an approach that not only makes intuitive sense, but has also fared well as others have faltered. Although there are undoubtedly many forward-thinking companies, anecdotal evidence and the realities of human nature suggest it is often easier for people and organizations to stick with the status quo than to risk making significant changes in the hope of making things better.

And as is often the case when more than a few people work together, it is not uncommon for groupthink or a few strong personalities to dominate the decision-making process, even if the results are not necessarily in the broader interest. Combine that with a natural human aversion to admitting mistakes or losing face, and it is not hard to see why some firms might choose to avoid cutting deadwood or becoming more focused if those who allowed things to deteriorate are still in charge.

Not so bad after all?

Despite the well publicized blow-ups, some recent developments suggest that activist investing will continue to be a strategy that can encourage or force companies to act in more shareholder-friendly ways, despite an environment that Mr. Solomon maintains is not supportive for such an approach.

For example, spurred by pressure from Carl Icahn and John Paulson, American International Group last week “pledged to return $25 billion to shareholders” and “unveiled a streamlining plan including a listing of AIG’s mortgage insurance arm, accelerated cost cutting and a separation of legacy assets,” according to the Financial Times. Is it likely that the insurer would have taken such steps without these well-known activists being involved?

Mr. Icahn was also instrumental in Friday’s announcement by Xerox that it planned to split into two companies, in what Reuters characterized as “a bid to be more nimble after years of trying to integrate the businesses.” While the Xerox CEO said “the strategic review had been underway before Icahn publicly revealed he had bought Xerox shares,” there seems little doubt that his interventions hurried things along.

Not just activism

As with all strategies that have been affected in some way by years of easy money and the Fed’s recent shift in direction, activist investing will experience some measure of the shakeout that Mr. Solomon predicts. Nonetheless, whatever does come about will likely reflect broader upheaval in the investment world, rather than the supposed shortcomings of this particular approach.

Michael Panzner

Michael J. Panzner is a 30-year Wall Street veteran and the author of three books, including Financial Armageddon, which predicted the 2008 global financial crisis.