Funds Hub

Money managers under the microscope

Caught short

July 3, 2009

Short-sellers have taken a lot of flak during the credit crisis, particularly last year when the slump in banks’ share prices eventually prompted the FSA and other regulators to temporarily halt the practice among financial stocks.

rtr24tfuHowever, it is worth remembering that for all the headlines of huge profits made by John Paulson and others, the practice is not a guaranteed winner and can result in painful losses.

SWIP investment director James Clunie – who is setting up a fund that can short and whose book on short-selling entitled “Predatory Trading and Crowded Exits” is published next month — sees dilemmas for short-sellers, even in stocks that fall.   

“In general, heavily shorted stocks do tend to underperform but the distribution is skewed. Every now and then there are big losses,” he tells me, adding this makes the practice harder to stomach for funds unwilling to take losses.

Clunie warns that crowded exits — where many hedge funds are shorting the same stock and then suddenly want to leave at the same time — can be particularly painful.

“The losses are not on a Volkswagen scale (when many funds tried to close the trade at the same time after Porsche said it had effective control of 74.1 percent of VW) but they are quite painful.

“You can lose 20 or 30 percent in 10 or 20 days. These are average figures.”


Not to mention how risky it is to be short with the Fed and Government propping up markets and printing money. Being short when inflation finally hits would be a nightmare.

I also think that Goldman, Merril, and others have orchestrated short-squeezes on stocks viewed as strategically important (and politically connected), like retail REITs. Why? Possibly because pensions and life insurers hold a huge % of this CRE debt, and some of the equity. I did a piece on the squeeze in SPG a while back, sorry for the shameless plug:


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