Hedge fund bashing never fails to go down a treat.
The standard line is long/short managers are profiteering pundits pouncing on falling markets and the poor fortune of others.
And the shorter they are, the worse they are.
Greece this week banned shorting for two months after Greek shares fell by 22% this year.
The SEC claimed this month long/short veteran John Paulson helped structure a complex financial instrument, which he then sold short.
It collapsed and he cashed in, the US market watchdog alleges.
The picture painted of ‘the predatory short seller’ is unflattering to say the least.
We list and test below some of the main gripes leveled against investors who can make money when markets fall.
1. Short sellers are nothing but opportunists.
Short selling is not all about jumping on short-term market discrepancies, says Leonard Charlton, manager of Dalton Strategic Partnership’s Melchior European hedge fund.
He says: “We look in the longer term for businesses with poor management, poor competitive positions, lack of pricing power and problematic end markets.”
Short sellers usually avoid strong businesses, even ones facing tough times. Data from analysts Data Explorers last week showed shorting of Goldman Sachs shares increased marginally from about 0.25% before the SEC charges emerged, to about 0.35% before retreating last week.
Similarly, Ryanair, which managers widely regard as sound, suffered short term pain from the UK flight ban and reimbursements to stranded passengers, but shorting of its stock hardly moved says Data Explorers.
2. Short sellers are short-termist.
Paulson’s spectacularly successful short punt on US sub-prime paid off in 2007, but did not for at least 12 months before, when he had to hold his nerve, and a position often registering paper losses.
Late in 2008 Lansdowne Partners was lambasted for shorting Barclays, even though the hedge fund was short the stock since Barclays’ bid for ABN Amro in 2007.
Barclays had often rallied, before plunging 53% in the final quarter of 2008. Dalton’s Charlton says: “We have shorts in our portfolio we owned for over two years.” He holds shorts for about as long as long positions, on average.
3. Short selling hurts markets.
On Wednesday, when Greece banned shorting, its markets rose by 0.6%. At least 14 national regulators outlawed new shorts in financial stocks soon after Lehman Brothers went bust in September 2008, hoping their markets would bounce back in a similar fashion.
They did not, at least not quickly, discrediting those who argued for the ban on these grounds. Shorting fuels supply of stocks, they said, and without strong demand prices fall sharply. Short sellers feed borrowed shares into markets, hoping to buy them back for less and pocket the difference. The bulk of academic research on the topic suggests this exerts minimal downward pressure on prices - indeed hedge funds buying shares to cover shorts can support the start of recoveries.
4. Short sellers always aim to profit from their bets.
It seems counter-intuitive to nay-say this one – of course, no investors punt to lose. But profit alone does not explain all shorting.
Antonio Borges, chairman of the Hedge Fund Standards Board, says shorting often aims to minimize losses on long positions in falling markets. In effect it allows supportive long positions to be retained, he adds.
Hedge funds dropped 19% in 2008, less than half the loss on global shares. If such cushioning allowed investors to stay invested for the 24% rise in equities last year, hedge funds should be praised, not pilloried.
Charlton says: “Short selling is a different kind of mentality, because it is not socially normal to believe that ultimately an asset is worth materially less than where it is now. Humans are optimistic by nature.”
In the long term, optimists win out. But in between times, healthy scepticism as exercised by short sellers can be useful, too.
