Making money in a falling market

Making money in a falling market
Comment E-mail Print Share
First Published: Wed, Aug 01 2007. 12 29 AM IST
Updated: Wed, Aug 01 2007. 12 29 AM IST
Short-selling: “Ready to go about?” For the past five years, investors have fired their cannons out of just one side of the ship. Stock markets have risen, so have bonds, and investors have boomed simply by going along. The rally has made for dismal returns among dedicated short sellers. Yet now, perhaps, their time has come. Investors are starting to poke their guns out of the other side of the ship too.
One structural sign of this turn in sentiment is the rise of the so-called 130/30 funds. These allow traditionally long-only fund managers to run limited short positions of up to 30% of the fund balanced by a 130% long position. A more immediate sign has been the rise in short interest in US stocks. On the New York Stock Exchange, net short positions have risen five months in a row—particularly among banks—to reach almost 13 billion shares, equivalent to eight days’ turnover. On the National Association of Securities Dealers Automated Quotations system, they’ve increased for seven months straight. A third indication is this year’s outperformance of large companies with genuinely stable cashflows. In a world where credit is tightening, they provide a safer haven than more leveraged, smaller or cyclical firms.
Market corrections are healthy, but what would happen if investors ganged up and rushed all their guns onto the other side? The risk then is that waves of short-selling could prompt distressed sales by some investors who might face margin calls. That would invite more short-selling, and so turn the correction into a rout.
Theoretically, it could be possible. That is what happened after the last equity boom in 2000, when short-sellers piled into firms such as the France Telecom Group and the ABB Group. Furthermore, hedge funds can change their investment strategies more quickly than the long-only money that dominated markets back then. Long/short hedge funds, which can shoot either way, alone account for almost a quarter of the $459 billion (Rs18.6 trillion) of funds under management in Europe, according to EuroHedge.
Thankfully, such a rapid switch looks unlikely. Firms are reporting solid earnings. And the poor performance this year of dedicated short-selling funds—down 2% against an almost 9% rise of the Credit Suisse Tremont hedge fund index—suggests investment officers won’t completely change their aim. That is just as well. As every captain knows, when changing tack, a stable ship needs equal ballast on both sides.
Comment E-mail Print Share
First Published: Wed, Aug 01 2007. 12 29 AM IST