* By Ronald D. Orol, author, "Extreme Value Hedging: How Activist Hedge Fund Managers Are Taking On the World" (Wiley)

Activist hedge funds have become a significant force in investing and wealth management. Today, there are over 150 activist hedge funds that cumulatively have over $100 billion in assets under management. That number has increased exponentially in the U.S. and for the first time these value-hungry investors are exploiting opportunities not just in the U.S. but around the world in dozens of countries including Ukraine, Russia, China, Japan and South Korea. Their growth and influence can't be ignored by the private investor.

Unlike the rest of their hedge fund brethren, who may engage in a flurry of trading on any given day, activist managers typically buy large stakes in a handful of corporations and engage management of these targeted businesses to find ways to improve stock price.

Share value improvement is an activist's primary goal but each manager goes about it in a different way. Most activist investors can best be described as quiet activists. They will only engage companies collaboratively, behind the scenes, in private board meetings with corporate executives. You won't hear about this category of investor on the covers of the major financial daily newspapers but you will hear about the blockbuster deals they often set in motion from behind-the-scenes conversations.

Activists Can Bring Special Expertise

Many of these investors will buy stakes only after receiving the explicit approval of those running the business in consideration. In these cases a partnership is often formed with the activist investor bringing its own industry, investment banking or other knowledge to a corporation seeking outside expertise. Particularly, in emerging markets, these quiet activists act as emissaries to international investment banking and other connections to help an isolated Chinese corporation, for example, expand globally.

The more high profile activist is the public insurgent. This manager may start out as a quiet activist, but he soon begins a public campaign to press CEOs and directors into taking action to improve the share value of the company.

Sometimes this involves nominating director candidates to replace management-backed board members. Other times, the goal is to gain the approval of a critical mass of investors and take that message to the company. The results can be stock buybacks and dividends, or long term governance improvements and operational changes. Having companies consider strategic alternatives usually means pushing management to have the business sold for a premium share price.

It can also mean lots of other things - real estate sale, lease back agreements, that can, for example, produce cash for business operations or a stock buyback. Most activist hedge funds that use public campaigns will do everything in their power to block a deal they think will do more for the CEO's golden parachute than shareholders wallets. Thus their goals are not what many have thought -like forcing a major mega-merger for a short-term premium at the expense of long-term share value.

Investors Will Lock Up Funds for Longer Periods

Unlike most other hedge funds, activist managers will often require their investors to lock up funds for longer periods, sometimes two or three years. These managers argue that the investment strategy actually better resembles that of a private equity fund than a hedge fund. In fact, most active long term managers say they try to understand the business they are investing in as well as the CEO running it. Buying a 5% or 10% stake in a corporation and engaging to extract value can often take a handful of years to accomplish.

Insurgent managers must feel confident that their private and institutional investors won't pull out half way through the effort while the stock of the target company is still languishing at roughly the same level it had been at the beginning of the campaign. A private investor that allocates funds to an insurgent without two-year lockups or longer should consider that if a particular insurgency campaign takes an extended period of time, other investors may cash out leaving the manager without the funds to successfully accomplish his value-extraction goal. (This happened to one prominent activist hedge fund that found itself with snowballing investor defections).

Many private investors that follow the strategy of activist managers will monitor the Schedule 13D Securities and Exchange Commission filing for notice that a public campaign has been launched. Once a high-profile activist files a 13D, which they are required to do when owning more than 5% of a company's stock, other investors pile on anticipating at the very least a short spike in the stock value. That improvement is typically short-lived and the share price drops as investors' cash out their short-term return.

Staying Put May Make Better Sense

These private investors should realize that sticking with the investment even after that spike drops down makes better sense. Even though the stock price may remain in the doldrums for a couple of years, during that time the activist has been agitating for change - either behind the scenes or as part of a public advocacy campaign that could involve putting director candidates on the board.

It may take a while but most activists are ultimately able to achieve what is known as a "catalyst," or major improvement in the stock price achieved through a number of actions. These may include a company sale or stock buy back. Those investing alongside the activists would probably be better served by holding onto the stock until the entire campaign has been completed. This does not mean share value will always be extracted. At times, even after all the energy and capital spent, an agitating investor will fall into the activist trap and experience major losses. Companies are also becoming more adept at responding to an activist campaign, faster and more effectively. Gone are the days, when activists could take advantage of an unsuspecting board that isn't in touch with the company's investor base.

Several Strategies for Private Investors

Bottom line: is this investment good or bad for the private investor? The answer is: it depends. Some private investors that are skittish about the lack of diversification in the strategy may be more inclined to invest in one of a large number of fund of activist funds that have emerged over the past few years.

With a fund of activists, the private investor has access to perhaps 10 managers and up to 100 investments. If a few managers don't do well in a particular period, the fund's overall return isn't affected in a detrimental way. Another approach is for private investors to diversify their activist investments from an industry and geographical perspective. As mentioned earlier, activists are beginning to set up funds targeting companies around the world, not just the U.S. Investing with activists operating in different locations could help maintain returns. Many private investors have asked for that kind of diversity.

Also, while an activist that specializes in a particular industry, say software companies or banks, understands those businesses and what it takes to improve value there, the same manager's fund can be susceptible to an industry downturn. If private investors are keen to invest in a fund that focuses all its energies on a particular sector, they may want to consider diversifying their investments with other activists or strategies.

One thing is for certain: activist hedge fund strategies are poised to undergo major transformations. In addition to globalization, activists are growing in assets under management. Some of the larger ones are targeting CEOs of major corporations with successful results.

Ralph Whitworth's Relational Investors success at Home Depot is one example, even though his success is in large part a result of the efforts of the retailer's institutional investor base. Another trend is technology: expect CEOs and activist investors of the future to battle over the future of the company by reaching out to other investors through YouTube videos sent to inboxes at the moment of a key vote. In one video the chairman and CEO explains why you should support the incumbent directors and in the other, an activist hedge fund manager introduces the nominees he hopes to install on the board.