Deep Dive: Short sellers are not just 'opportunists, speculators and profiteers'

John Leiper, CIO at Titan Asset Management, explained that the ability to ‘go short’ “improves market liquidity and broadens the range of investment strategies that can be employed by an asset manager”.

“Markets spend most of the time going up, but that trend cannot last forever.”

He said markets are subject to cycles, driven by both “behavioural biases and the ever-evolving macroeconomic backdrop”, which would “typically results in declining asset prices. Asset managers can benefit in such an environment by shorting stocks thus generating profits for clients that they might otherwise struggle to provide”.

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However, the execution of this strategy carries significant risks as and “may not be appropriate or suitable for the average investor,” Leiper said.

“Theoretically, the risk of loss is unlimited, as there is no capped upside to a share price versus the certainty of a zero valuation.”

He said there were also ethical consideration around shorting. “as it can make a bad situation worse for a company that might otherwise turn things around”.

“In extreme scenarios, short selling can exacerbate market movements undermining investor confidence leading to broader contagion.”

This was something Duncan MacInnes, investment director at Ruffer, who deploys shorts on his portfolio, was acutely aware of, describing “short-sellers [as the] much-maligned participants of financial markets – an easy target for CEOs, politicians and newspapers to blame when markets are sending them signals they do not want to hear”.

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“Opportunists, speculators, profiteers, ‘betting against the American Dream’ – the connotations are seldom positive. One hallmark of a crisis is when somebody suggests banning short sales,” he said.

“The truth is lies somewhere in between this view and its shadow – that short sellers are noble truth seekers diligently striving to ensure that asset prices reflect fundamental value and kicking the tyres on the official narrative. In any case, it would be wrong to caricature short-sellers or even to think of them as a homogenous set of investors.”

Leiper agreed the practice was not totally negative, arguing that “when used correctly, short selling is a viable tool that can be employed to benefit investors and improve capital market efficiency”.

On MacInnes’ own portfolios he utilises shorts to make his overall fund “more robust and ‘all-weather'”, which entails more than shorting stocks on an equity-by-equity basis.

Calling it a “protective toolkit”, MacInnes said: “We think of short positions a little more holistically, and always in the whole portfolio context. Being able to judiciously use shorts as a hedge in portfolios opens a whole new world of portfolio construction, it is an immensely useful tool which requires a different skill-set and operational infrastructure.”

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For example, in 2022 he held several energy and value stocks and hedged this with a short “on a basket of profitless tech stock” taking a “nuanced” and “finessed” risk allocation.

There are also other shorting methodologies, such as the one employed on Callum Abbot’s JP Morgan UK Equity Plus fund, which runs short securities “considered less attractive to improve potential returns without increasing the overall net exposure to the market”, otherwise known as a 130/30 or ‘active extension’.

He said there was a general tendency for active extensions to overweight small- and mid-cap stocks, “typically because these stocks are not as well covered by the sell side”, a practice he largely agreed with.

Abbot used shorts to “help generate differentiated alpha”, while seeking to “control risk – particularly size risk”.

He said he has “consistently found attractive short opportunities in what we regard as flawed concept stocks”, which are usually “rapidly growing as their concept has shown some initial uptake but loss making and, in many cases, burning cash.”

“They often promise significant market opportunity as their concept achieves mass take up.”

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Neil Robson of Coluombia Threadneedle Investments uses the same 130/30 tactic on his CT Global Extended Alpha fund.

Juliet Schooling Latter, research director FundCalibre, said this method allowed Robson to “to extend investors’ potential returns”, making returns on stocks he is bullish and bearish on, which the manager described as “lining up on the starting grid for a motor race with an engine 50% bigger than everyone else’s”.

Another manager Schooling Latter highlighted for utilising the benefits of shorts was Man GLG’s Mike Scott, who she said “demonstrated excellent stock picking ability throughout his career and brought that talent into this fund, while also expanding his investment flexibility to being able to take short positions and thus potentially benefit from falling prices too”.

She said this tactic had “paid off with the fund top in its sector returning more than 30% compared with 7.5% for its average peer” since launch in 2019.


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