On Short Selling

Short seller Nathan Anderson to shut down Hindenburg Research

“We have all worked extremely hard, with a focus on precision and letting the evidence dictate our words,” Anderson wrote in Wednesday’s announcement. “Sometimes this meant taking big swings and taking on fights that are much bigger than any of us as individuals.”

There are many things to like and dislike about financial markets, the data, the discussions, the engagement across industries and sectors. Why is everyone always angry at short sellers, what have they ever done to you?

On the buy-side, all the work we do is supposed to lead toward a relatively straightforward outcome: to buy or sell an asset. Largely, I think it is fair to generalize that most of the time, if we do not own the asset, the decision is whether to buy or not, and if we own it, whether to sell it (or hold).

This seems, to me, to be an uncontroversial process. Nobody has a problem with a fund investing in something because they believe their evaluation is better than the market’s, that the asset will be worth more than it currently is. When it comes to exiting a position, this too is largely uncontroversial.

In his book ‘Grow the Pie’, Alex Edmans writes about assets changing hands as a reallocation of capital from one firm to another. At the agreed upon price, the willing buyer believes himself to be a ‘more suitable’ owner of the stake than the seller. Why, then, is it different to reverse the logic? If I think something will be worth more, I buy it from someone who thinks it will be worth no more (or less)¹ So to express my view on an asset, why can’t I say ‘I believe, based on my research, this thing shouldn’t be worth what the market is pricing it at’, and if this is my belief, then be allowed to act on it? It seems reasonable that a firm should be able to turn this into a trade, and profit off of being correct. Isn’t that what the whole game is about? To make a profit when we are correct, and to lose money when we are wrong?

Yes, short selling is largely connected to short-term financial gain. That’s why it takes place in financial markets. We are not children, after all, this is serious business. Every participant in the market, at scale, is a sophisticated investor. Ever signed one of these? You don’t get to cry foul when a long position doesn’t work out because the market disagrees, why would you cry foul just because a part of the price movement against you came from someone taking a different view?

You can argue that a short seller is different to other market participants in that owning the security ‘adds’ to the stability of a company, while short selling it does not, but again I would argue that this misses the other side of the equation, that of the buyer in the short sale. Whether a firm buys its position from a short seller or not (if they even know) does not change their own decision to invest directly. They are acquiring, at a price they deem reasonable. In every asset transaction, there has to be someone entering and someone exiting a position.

Nobody likes a cheat, and I’d be the first to condemn any level of market manipulation or active deceit. Short sellers who spread lies and rumors are just as harmful to the system as any other market participant fabricating stories to favour their position.

Bill Ackman’s 2.6bn trade after COVID, was a fantastic short. Maybe it was fine because most people don’t understand CDS trading? There was some controversy here, too, because he talked up the market while building his position, and then made it known that he was worried. I like the trade in part because to build his book, he did not lie, he just took advantage of the perception of other market participants. Nobody sold him CDS protection (for which he had to pay a fair bit, too) without financial knowledge or a view on the markets, theirs was just different. There’s something satisfying about a great trade, because it’s a result of being right. Shouldn’t we celebrate that, regardless of long OR short?

If we set aside the lamentations of short targets for a moment, the research by Hindenburg was detailed, and did not contain fraudulent information designed to deceive the market. The firm made its case, put together supporting documents, entered into positions, and waited for the market’s reaction. If they were wrong, they lost money. That’s it, isn’t it?

We celebrate (largely) the activists who call for efficiency, who call for better corporate governance, or more sustainability. Why not the ones who call out misbehaviour, who question whether our understanding of an asset is really correct? After all, if we are right, we’re all too happy to take their money away.