The Value In Listening To Bears

Short sellers are a breed apart. Because they’re going against the trend, and numerous stakeholders, they possess a tenacity and conviction that can be breathtaking. When I was investing in hedge funds at JPMorgan, I especially enjoyed meeting with bearish managers. For a start, they do some of the best research. And while a long position might require only modest upside to justify its inclusion, shorts are often believed to be fraudulent, or to have fatally flawed business models. A short seller’s pitch has passion laced with a paranoid suspicion of authority, financial statements and basic human goodness. It can be exhilarating to hear such well-constructed certainty that much you believe right in the world is wrong. These people are fearless, the ones you’d want with you in that foxhole.

In The Hedge Fund Mirage, I recount meeting with short-seller Marc Cohodes, who was convinced that men’s clothing store Joseph A Banks was misreporting its financials and would soon collapse. He brandished ads offering “Buy One Suit, Get Two Free” as evidence of an unsustainable promotional strategy. That was over fifteen years ago, and they’re still in business. Examples of such bets gone awry are easily found. For a while, Marc Cohodes was disillusioned with the business (see A Hedge Fund Manager Finds More to Like in Farming), but has since returned (see The World According to a Free-Range Short Seller With Nothing to Lose).

Conversations with hedge fund managers are rarely boring, but they’re especially absorbing when discussing short positions. The depth of research and unshakeable conviction are awe-inspiring. Even though many are wrong, the notion that an apparently successful company is really a house of cards remains riveting.

Nonetheless, shorting profitably is harder than making money on long positions. Almost everyone else involved wants the stock to rise, and because short positions grow when they’re moving against the short seller and shrink when the price is declining, they’re harder to manage. I often used to ask hedge fund managers why they bothered shorting stocks at all, instead of simply shorting index futures and investing all their effort in long ideas. I never received a satisfactory answer – when companies or sectors do collapse, such as Enron, sub-prime mortgages, Lehman Brothers or Valeant, those who called it draw immense satisfaction, media accolades and more clients.

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SL Advisors is the sub-advisor to the Catalyst MLP & Infrastructure Fund.  To learn more about the Fund,  please click here.

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