Those fund managers doth protest too much.
Over the past week, the Financial Review letters page has been gazumped by an almighty stoush between some of the biggest names in active fund management and their shadowy brothers, in the absolute (hedge) fund trade.
Geoffrey Travers of CCZ Stratton Equities alleged that “short selling is … destroying confidence in market prices.” (Others may argue that incompetent management and a possible global depression is the major cause, but who are we to let facts get in the way of a scapegoat?) Graham Middleton of Synstrat Management compared short-sellers to Jesse James, noting that “any company setting out to raise additional capital now faces the threat of being immediately short sold.” (Ignoring the obvious retort that many of these companies shouldn’t be raising capital at all). Meanwhile, the oft-quoted Anton Tagliaferro of Investors Mutual called for short-selling to be banned, alleging that it “can disrupt the process and unsettle the allocation of capital.”
While long-only fund managers accuse short-sellers of being the cause of all market ills, that argument was weakened by the fact that the share indices suffered most when short-selling was banned. Further, accusations that short-sellers are gamblers or brazen speculators is not technically correct. Many traders who utilise short-selling adopt “paired” positions, that is, they will short one company (say Rio) and purchase another (like BHP) — hoping to profit from the differing relative values.
In other instances, short-sellers will take a “directional position” selling a company’s shares in the belief that the market has over-valued the company. A prime example would be the case of ABC Learning Centres in 2006, which was valued by long-only fund managers at $3 billion, when in actual fact its intrinsic value was probably zero. Many fund managers failed to properly analyse ABC’s financial statements and gullibly believed the company’s now-disgraced executives. Short-sellers most likely expedited ABC’s downfall, but that is a good thing, as it prevented ABC from raising further debt or equity to bankroll its non-profitable operations. The exact argument preferred by fund managers as to why short-selling should be banned.
In yesterday’s Financial Review, Greg Cooper, CEO of Schroeder Investment Management, accurately noted that “short sellers are not responsible for the sub-prime crisis, the destruction of corporate balance sheets through toxic investments or the share downturn in the global economy … the blame for that can arguably be paced that the feet of ‘long’ only investors, banks, companies and households with excessive amounts of leverage and a carefree attitude to risk and reward.”
Of course, not all short-selling is to be encouraged. Nefarious types who spread untrue rumours in order to profit from a company’s demise should not be tolerated. Further, allowing a financial institution which is guaranteed by the government (and therefore, the taxpayer) to be shorted in such turbulent times is not a wise idea. If short-sellers cause a run on an otherwise solvent financial institution, a great deal of unnecessary taxpayer loss results.
However, in general, there is nothing wrong with short-sellers revaluing the market capitalisation of poorly managed businesses. Instead of criticising short-sellers for believing that companies like Asciano and OZ Minerals are over-valued, those long-only fund managers should be calling for the heads of the multi-millionaire CEOs and directors who caused the problems in the first place. (As Crikey noted yesterday, long-only fund managers have not exactly been quick to discipline non-executive directors, voting to re-elect the Chairman of ABC’s audit committee as Chair of Transurban and appoint a former Allco director to the Qantas board).
Long-only fund managers presumably don’t like seeing the value of their portfolio (and in effect, their earnings, which are partially calculated based on funds-under-management) drop as a result of short-selling. But the market does not exist to fund the lifestyles of millionaire ticket-clippers who have gotten rich on the wings of a debt-funded boom. Markets rise and inevitably fall. To profit from its rise but attempt to restrict a correction is hardly representative of a free-market.
Disclosure: Since 2007, the author has at various times held short positions in the ASX200, S&P500, ABC Learning Centres and Asciano.