Yahoo will buy back 40 million shares from Third Point, reducing its stake in the internet giant to less than 2%.
Mr Loeb was a key driver of the recent management shake up at Yahoo that saw the departure of former chief executive Scott Thompson and the appointment of Marissa Mayer in the role.
As a result of his reduced holding, Mr Loeb has resigned from Yahoo's board.
Two other directors, Harry Wilson and Michael Wolf, who were nominated to Yahoo's board by Third Point, have also submitted their resignations.
"I'm confident that with Marissa at the helm and her team's focus on innovation and engaging users, Yahoo has a bright future." Mr Loeb said in a statement.
The move by Third Point comes amid a surge in Yahoo's stock. Its shares have risen more than 70% since Ms Mayer took charge an year ago.
According to a statement by Yahoo, the internet giant has agreed to pay $29.11 per share to Third Point. valuing the deal at $1.16bn (Â£750m).
That is almost double the average price paid by Third Point while accumulating its stake in Yahoo - resulting in gains of almost $600m for Mr Loeb's fund.
Some analysts said the decision by Third Point to sell its shares could prompt other investors to think that the surge in Yahoo stock may have hit its peak for now, prompting them to follow suit.
"Probably a lot of investors are saying, we had a pretty good run here, it makes sense to take some off the table," said Ronald Josey an analyst with JMP Securities.
"Much like a lot of investors followed Third Point in, a lot will follow Third Point out."
Yahoo shares fell more than 4% in New York on Monday to close at $27.86.
Third Point LLC, the hedge fund headed by activist investor Daniel Loeb, has agreed to reduce its stake in Yahoo.