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Does It Pay to Mimic Carl Icahn's Moves?

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Being an activist investor is a hard way to make a living. The typical practitioner first spots a company that is performing badly because of management mistakes. Then the activist buys a big stake in the stock and begins pushing for changes. Activists may advocate raising the dividend or replacing the CEO.

When an activist succeeds, the profits can be huge. Among those who have made fortunes by shaking up corporate boards are Carl Icahn, Nelson Peltz and Bill Ackman.

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Should you invest in stocks that are targeted by activists? Not necessarily, says Ken Squire, portfolio manager of 13D Activist (MUTF:DDDAX), a mutual fund. While some of the top activist investors have strong long-term track records, many other players deliver subpar results.

To separate the stars from the also-rans, Squire tracks all of the approximately 1,500 13D documents that are filed at the Securities and Exchange Commission each year. Investors must make a filing when they have acquired more than 5% of a company's shares. Squire monitors each deal, assessing the obstacles that activists face. He analyzes investment track records, determining whether an activist excels in particular industries or types of deal. Squire sells the data to activists and institutional investors.

In December 2011, he opened the activist mutual fund, which invests in 20 or so stocks that have been involved in 13D filings. The fund aims to outperform the S&P 500 (INDEXSP:.INX). Just as important, Squire seeks to provide diversification because activists can push up stock prices during weak markets. So far the approach has been succeeding. In 2012, the fund returned 21%, outpacing the S&P 500 by 5 percentage points. During the fourth quarter of the last year, the portfolio returned 5.2%, while the S&P 500 sank slightly into the red.

One of Squire's favorite holdings is Agrium (NYSE:AGU), which operates two businesses: a retail operation that sells fertilizers and a wholesale business that distributes potash and other crop nutrients. JANA Partners, an activist hedge fund, holds 6% of the shares and has argued that the company should be split in two so that each major line could be operated separately. The activists are seeking board seats, calling for cutting costs and strengthening the company's working capital.

Squire says that JANA Partners has a track record for outperforming the S&P 500 by a wide margin. He says that the activist has a good chance of success with Agrium because there are a variety of factors that could push up the stock price. "Even if they fail to split up the company, the stock could rise if there are better cost controls or better capital allocation," he says.

Stocks often bounce after a 13D filing is announced. But Squire says that it is not too late to invest after the initial jump. He says that the average holding period for an activist is 15 months. Often the deals take longer to complete, and some of the biggest gains occur late in the game.

Squire owns Howard Hughes (NYSE:HHC), a stock that has benefited from a long period of activism. In 2010, veteran hedge fund operator Bill Ackman became chairman of the company, which operates commercial developments, including a Las Vegas project that was owned by the estate of billionaire industrialist Howard Hughes. Ackman is known for a series of high-profile activist moves, including investments in Target (NYSE:TGT) and Procter & Gamble (NYSE:PG).

As chairman of Howard Hughes, Ackman has faced a series of problems. Some of the real estate projects stumbled during the financial crisis, and development efforts were forced to halt. Now Ackman is obtaining financing and pushing forward with projects. "This is a situation where the activism has paid off, and they are running the company more efficiently," says Squire.

Squire also holds DineEquity (NYSE:DIN), which owns two restaurant chains, Applebee's and International House of Pancakes. Last year hedge fund Marcato Capital Management made a 13D filing and called for the company to increase its dividend. Squire says that the activist effort is likely to succeed because the company has plenty of cash flow. The hedge fund is not calling to replace management. "I like this kind of deal because the activists can succeed without restructuring or overcoming major obstacles," he says.

At the time of publication, Luxenberg had no positions in securities mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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