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5 wealth managers on the ethics of short-selling
on Jul 15, 2014 at 13:09
With Quindell's share price still reeling from Gotham City Research's bear raid, we asked readers their views on short-selling.
Matthew Hunt, principal, Prospect Wealth Management
‘Short selling often attracts opprobrium because it is associated with speculators making gains at the expense of long-term investors. In principal though, it is as legitimate an investment strategy as taking a long position.
‘The problem with shorting equities is that over time most equity markets rise in price, so generic shorting strategies are at an inherent disadvantage. For example, the Dedicated Short Bias Index produced by Credit Suisse shows hedge funds specialising in shorting provided protection for limited periods during the financial crisis, but over the longer term, significantly underperformed a long-only strategy. But Gotham City’s approach shows shorting can not only improve market efficiency but be highly profitable as well.’
James Calder, research director, City Asset Management
'Short selling is an emotive subject as it is tarred with the evil capitalist brush. However it does provide good as it can highlight companies that have structural issues or in the worst cases those that are embracing fraud to the detriment of their shareholders and of course the vast majority of their employees. Long/short funds have become much more accessible to the retail investor and in our view are a credible tool in the fund selection box.
However whilst it is perfectly legal for a hedge fund to publish research highlighting a short position they hold is it morally justified? On the one hand there are some long only managers that are quite willing to go to the press highlighting stocks within their portfolio to hopefully benefit their performance. So why should a manager taking a short position not do the same thing?
The effects of the short research can have a much greater impact and if they are wrong can create unwarranted damage whilst still benefiting the issuing house. Whilst shorting does increase efficiency in markets and in company management’s behaviour, its less than equitable use may create a strong case for increased regulation in an industry that is already subject to rigorous regulation.'
James Maltin, investment director, Rathbones
'While the views of the short-seller are diametrically opposed to those of the long-only investor, their motivations remain the same, namely to generate profit. To evaluate the ethics of such practice, we should turn to its origins, which trace back to Alfred Winslow Jones, a socialist, journalist and by 1949, arguably the world’s first hedge fund manager.
'Throughout the first half of the 20th century the standard approach of professional investors was simply to buy stocks when they expected prices to rise and hold cash when they were due to fall. Jones broadened these options by borrowing money to increase his long position and borrowing shares to create a short position. By combining these long and short positions he could control risk, rather than being subject to the whims of the stock market, and by introducing portfolio insurance, Jones could buy more of the companies he liked without worrying about the movement of the broader index.
'Given that the stock market cycle of boom and bust that many fear can only arise if the market is dominated by trend-following behaviour - people buying in response to price rises and selling in response to price falls - then arguably short-selling performs a socially useful contrarian function: creating immunity to market direction, the short positions in the properly managed hedge fund remove the manager from the herd, therefore serving the broader investment community.'
Andrew Morgan, portfolio manager, Walker Cambria Investment Management
‘Some tactics used by short traders have been unethical – manipulating the market, for example, by using smear campaigns to drive down a target stock. But that’s an argument against market manipulation and bad behaviour, not short selling per se.
‘The role of short-selling in boosting the market’s efficiency and liquidity is well known, as is the depth of much research carried out in its cause.
‘But short-selling isn’t just about profiting from falling prices or carrying out raids on stocks. For me, the most important thing is that it’s a tool in many hedging strategies, often providing a central role in risk management.
‘As our industry develops, I believe the focus of many portfolio managers will switch from generating alpha to solving clients’ needs through risk management. Achieving a client’s investment objective via the best possible risk/return trade-off seems both sensible and ethical to me. It would be a shame if short selling were unable to play its part in that.’
John Dance, principal, Vertem Asset Management
‘I can’t help feeling there are typically more synthetic sellers than synthetic buyers, which gives short-sellers an advantage in terms of trading momentum. Successful short sellers will often analyse how much additional “short interest” a stock has before taking action, usually in the belief the more short-sellers that are, the more successful they are likely to be collectively. This can lead to short selling being a self-fulfilling prophecy.
‘It may seem harsh on long-term investors that the value of their holdings can be decimated in days or hours, but it can open opportunities to invest at attractively low levels. As long as the short-seller has a justifiable rationale to short, such as overbaked valuations and earnings expectations, I don’t see a major issue. It becomes more contentious when they attack stocks that are generically suffering weak sentiment, such as the banks in 2008 and 2009. The lower share prices became, the more vulnerable banks became as it was more dilutive to raise capital. Again, a self-fulfilling prophecy.
‘As a user of short-selling strategy funds and taking direct short positions for clients, I guess I am comfortable with it.’