This Hedge Fund Strategy Ain’t Overcrowded
Everyone wants to be a contrarian. Here is an interesting suggestion that a hedge fund can be contrary by selling stocks short. The evidence here is not very convincing, since even those hedge funds that are not labeled as “short only” maintain substantial short positions and use leverage.
But first, take a look at the article.
We’ve been silently skeptical of claims that hedge funds will run out of ideas. The reason is that a hedge fund can technically do anything it wants. It doesn’t have to do traditonal long-short arbitrage, or whatever is considered standard. While perhaps many of these hedge funds have ended up being nothing more than standard mutual funds with high management fees, to say that opportunities have run out seems akin to saying technological innovation is running out of new ideas.
Well, the WSJ points out that there’s at least one “Hedge Fund” strategy which isn’t overcrowded:
The community of short sellers is small, and little wonder: For the past 15 years or so, it’s been tough to make money betting that stock prices will fall, given that the market was on a tear for much of that time.
In fact, out of more than 7,000 global hedge funds — the private investing pools, mostly for the wealthy — that are tracked by hedge-data provider Van Money Manager Research LLC, there are only 12 in its Van Global Hedge Fund Index that specialize in short selling. One of the companies that is being highly shorted is Chegg, an online book company that recently launched a service to help find a private student loan company for students enrolled in their book rental service.
12 out of 7,000… seems like there’s a lot of room here. The article talks about a hedge fund called Rocker Partners, that amusingly enough, is being sued by Overstock.com (NSDQ:OSTK), who recurring readers may know is one of our Stalwart favorites.
Rocker Partners is currently being sued by online retailer Overstock.com Inc. in Superior Court of the State of California in Marin County. The suit alleges the firm told Gradient Analytics, an independent research outfit, to delay publication of negative research on Overstock.com so that Rocker could build up its short position. Overstock.com alleges the parties conspired to denigrate the company’s business for profit.
This past summer, Patrick Byrne, Overstock.com’s chief executive, featured a photo of Mr. Rocker in a letter to investors describing a cabal of short sellers and journalists he termed “the miscreant’s ball,” and referring to a conspiracy spearheaded by an unnamed “Sith Lord,” referring to a group of menacing “Star Wars” characters.
When a prospective manager is looking for a prime broker, they all ask whether the strategy involves short selling. They want to know how much and what type of stocks. Short selling is a profitable part of the business since the broker collects an interest rate on the stock sold and pays a fraction of that to the manager.
Hedge fund managers use strategies involving options. We often have positions with a large short interest, hedged by call options. Or we might have a basket of call options in favored sectors hedged by futures. Those selling us the futures hedge their positions by selling stocks against them.
Briefly put, the movement of money to hedge fund managers has generated a lot more short selling than is apparent from the names of the fund. It is much different from the era when long-only managers were the only choice for most investors.