The post-2008 era of zero rates and soaring stocks was a chastening era for many long/short equity hedge funds.
Money flowed into passive equity strategies, often via ETFs, delivering rich gains for small fees and making active managers look expensive in comparison. Short-selling fell from favour, with big names like Lansdowne Partners retreating from the strategy.
Then came the meme-stock craze early in 2021. Even David Einhorn, the famed US value investor and founder of Greenlight Capital, changed tack after retail traders used online forums to collectively bid up companies where there was known short interest, most notably GameStop.
‘People were just hunting for short interest. We’ve reacted to that,’ he revealed earlier this month at the London Value Investor Conference.
‘You have to take smaller positions. We’ve also made it a little harder for people to figure out what we’re shorting, because sometimes it feels like they’re looking for you. We’ve stopped talking about what names we’re shorting.’
A new approach helps. More important, perhaps, will be the new market environment described by the likes of Jim Chanos as a huge short-selling opportunity.
Marc Chatin, a portfolio manager with Parus Finance, a long/short equity manager based in London, tells Spear’s it is ‘a game-changer for short opportunities’. Their short book had one of its strongest years in 2022.
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‘Short opportunities tend to be companies with balance sheet problems, mostly holding too much debt. Life becomes more difficult for them with rising rates.’
But it is a hard discipline and timing is important. ‘The volatility of the market means we don’t short all the time and only target extreme short opportunities — where we think a stock will go to zero, or certainly more than 70 per cent.’
He adds that ‘pressing the short on the way down’ is the way to maximise returns from short-selling. The outlook is positive: ’All the main beneficiaries of lower rates will be hit negatively during this hiking cycle,’ says Chatin.
Active vs passive management in the age of AI
Charles White Thomson, CEO at Saxo UK, believes the case for short-sellers and other active managers is looking strong once more.
‘Active management, which includes long-only and hedge funds, is a key part of a stable and healthy financial ecosystem,’ he says.
‘For many years now I have thought of the short-seller, like a shark, as an endangered species,’ but that is changing. ‘The voice of hedge and active funds has got louder and is better suited for these challenging times, despite the negativity from a selection of our financial influencers.’
He sees them as ‘ChatGPT busters’ with the experience to outwit — and outperform — AI. ‘They have the ability to cut through the noise and harness their wisdom. A bit like sharks, the much-maligned and magnificent creatures of the ocean that have seen many of the world’s seismic changes but continue to go about their business.’
The hangover from the disappointing era remains. Almost two-fifths (38 per cent) of respondents to BlackRock’s latest family office survey expressed disappointment with hedge fund performance.
One US family office dismissed ‘a lot of equity long/short [as] just equity beta.’
The CIO added: ‘We pay a lot for it; it hasn’t helped us. So, we’ve spent a lot of time really thinking about the beta and the characteristics of that diversifying part of the portfolio, and then… building a lot of private allocations to give us that diversification and market exposure.’
Marc Rubinstein, the former Lansdowne hedge fund manager who shut his financials-focused strategy in 2016, and now writes about finance, sees a resurgence ahead for short-selling.
‘I think it’s a very valuable skill and I think it will return. There’s a kind of cyclical component to it from a business perspective and the tailwind’s behind it right now,’ he said in a recent podcast.
The rationale for shorting and crafting a risk management strategy around it is ‘very compelling,’ he added, particularly in a new volatile market environment.
‘Clearly with markets not going up to the degree they were in 2020 and 2021, there is going to be increasing scope to do that.’
Time will tell if the optimism is borne out by strong risk-adjusted returns in a strategy which fuelled so much of the hedge fund industry’s rise in the decades leading up to 2008.
Will Wainewright runs Alternative Fund Insight, a news and research platform covering hedge fund and private markets
