Banking Crisis
The Short Seller As An Endangered Species - Should We Worry?

The author of this article claims that short-sellers resemble sharks as an endangered species. (People sometimes use the term "shark" about financial players for less flattering reasons.) He says that the decline in shorting is bad for liquidity, price discovery and efficiency. Markets are being pushed out of balance.
The short-seller is not a figure people typically warm to or
celebrate. Governments have sometimes banned “shorting” (the
practice of borrowing a security with the aim of selling it and
repurchasing it at a lower price, and profiting from the
difference). Amid the 2008 financial crash, governments such as
those of Germany and the UK slapped limits on the technique. But
overall they have left it alone. And with good reason: shorting
allows market participants to act on a negative view of a
security without taking the more drastic view of selling it for
good. It arguably adds more players to a market and increases
liquidity and price discovery. It compresses bid/offer spreads
and reduces some of the frictional costs of the market.
In an age of massive central bank money creation (quantitative
easing), a policy of “financial repression” designed to boost
equities, how can short-selling be a viable tactic? Charlie
White-Thomson, CEO, Saxo Markets, addresses
that question and discusses other features of the shorting
landscape. He gives a fascinating and brief tour of an aspect of
markets that is not always as clearly understood as it should be.
(This publication also intends to examine the role of
derivatives, such as options, in portfolio management. Stay
tuned.)
The editors of this news service are pleased to share these
insights and welcome replies. Jump into the conversation! Email
tom.burroughes@wealthbriefing.com
and jackie.bennion@clearviewpublishing.com
Last week I read with a touch of nostalgia that York Capital announced
that it would wind down its European hedge fund business to focus
on longer-duration assets. This decision has been driven by
lacklustre returns in some of their strategies. Credit Suisse is
expected to take a $450 million hit on its investment in York
Capital (see
this report). In 2010, I was sitting in the equity trenches
of Credit Suisse Moscow and clearly remember the internal
announcements discussing this investment.
The list of such closures is growing and this follows on from the
August announcement by Lansdowne Partners - that it is stopping
short selling in its flagship £2.8 billion fund. Its statement,
or part of it, alluded to the difficulties of selling short in
this overstimulated market.
It encouraged me to think about the early 1990s and the launch of
many short strategies, including Lansdowne Partners and York
Capital. The Lansdowne Partners launch was led by fund
managers out of the preeminent stable that was Mercury Asset
Management. So many great names that are no more - SG
Warburg, Morgan Grenfell, Barings Securities. All consumed
by greater beasts in the food chain.
It is undoubtedly true that the life of a short seller in the
face of gargantuan quantitative easing is a tough one. The
liquidity pumped into the markets by central banks covers many
sins and can make structurally poor companies with limited
futures share prices perform well. Good and bad go up with the
tide in this environment. The inflationary pressures are also
significant but that is for another day.
At a time where a large number of investors seem to be thinking
that the only way for stocks is up, short sellers like sharks
help to keep things honest and their worlds on an even keel. They
speed up nature and challenge the underperforming or weak.
Assisted by their “amupllae of lorenzini” - or in the case of
short sellers, corporate analysis - their aim is to find their
prey or structurally challenged companies, and in doing so,
restore faith in the markets.
A good example would be a company like Wirecard - where
short sellers sold the shares above €100 and closed their
positions when the share price had collapsed to €2, a view that
has since been vindicated not merely on the value of the company,
but also on its governance, something that short-sellers are
often first to identify. Finding these companies is hard work and
not without significant risk - by definition, the risk of being a
short company is unlimited. This is partly why the regulators
require hedge funds to declare short positions, with those
thresholds becoming even more stringent during times of
heightened market stress, such as during the current pandemic.
Transparency is key and provides useful information to retail
investors.
The list of short selling funds who have stepped back or closed
is growing and this will harm the efficient functioning of the
markets. The demise of short-sellers, many of whom are outspoken,
larger than life characters who enjoy swimming against the tide
and armed with conviction, is a shame and will make the markets a
more dangerous place.
Short-selling is much more than about hedge funds. It is about
the individual investor, avoiding groupthink, taking an active
rather than passive approach to investing and risk management,
using all the tools in one’s investment arsenal to generate the
optimal balance of risk and return. We live in a world where the
mantra is “long only” investing, tracker funds or buy and hold.
Woe betide those who cloud the message of this religion or
established order. There is an institutional lack of focus and
education around short selling, as a valid strategy, either
backed by conviction or as part of a market neutral long-short
strategy. Phrases like “TINA” or “there is no alternative”
when referring to the equity market should be a warning or
message to the bravest investor.
Short selling is an important risk management tool and allows
investors the opportunity to hedge their portfolio or to profit
from declines in the market, if they believe that prices will
fall. This should be a discipline that retail investors
understand and have easy access to and not just the prerogative
of the few.
It is worth noting that though painful and bruising, the closing
of a trading strategy or fund, is nothing compared with the
demise of those most majestic top predators - destined to swim
constantly without rest, hunted remorselessly, trapped in nets
and thrown back to the sea, or to have their fins hacked off for
soup.
The World Wildlife Fund notes that with our oceans severely
degraded, restoring sharks is key to improving the resilience of
our waters. The same can be argued for our financial ecosystem,
with the increasing absence of short sellers and access to the
tools to go short, we risk financial markets turning into an echo
chamber which lacks that all important balance of views and
positions, and this, as history shows us, tends to end badly.