Short-sellers: friend or foe?
The VGI thesis on Corporate Travel Management (ASX: CTD) has certainly been grabbing the headlines. Catching up on the weekend media, you only have to google “VGI + Corporate Travel” and there is at least 10 plus updates from various publications over the last 30 days. There is certainly a dichotomy of opinions on the topic, especially amongst the financial intermediary market.
Some think the publicity is great as it keeps company management “honest” and “on their toes” whilst others see this as a play by VGI to create their own catalyst and build momentum for their short trade. I thought in the context of these views it might be worthwhile exploring some basics around short selling and the disclosure requirements on the ASX, and what benefit short-sellers may have in the market.
Revisiting the basics
In sourcing a succinct description of short-selling, I have gone directly to the regulator in ASIC who describe it as“an activity where a person enters into an agreement to sell a security that the persons does not own. Short sellers need to make arrangements to cover their delivery obligations to the buyer before they fall due.”
A common question I am asked is why would a person (or organisation) be willing to lend a security to a short-seller when it goes against of the interest of the shareholders, including themselves? A simple answer to this is not all persons (or organisations) own a stock because they have conviction in the underlying business (believe it or not!).
For example, index funds will need to hold a market cap weighted portfolio, and therefore will have weighted positions in certain stocks based on their concentration in the index. As such, passive strategies would be a larger lender of securities on the ASX, who in turn get paid a borrowing fee or interest for lending their stock which would be dependent on the loan term and holding liquidity.
Other lenders of securities can include larger investment banks or industry superfunds. Essentially, the short-seller would source the security they would like to short through a broker (retail or institutional), and upon borrowing the stock they would then sell it back on the open market. The short-seller would make a profit from the stock thereafter falling in price and would “cover” the position by buying the stock back on market and would consequently return the security to the lender prior to the agreed date. The risk the short-seller takes is that the stock price of the security they short can, in theory, rise to infinity (so there is no cap to their losses), however the readership of the blog may have seen more stocks go to zero than infinity over their lifetime!
What are the disclosure requirements?
Being close to the trading here at Montgomery, I know that our team are obligated to send a daily summary of all the short trades (transaction and position) we place on the ASX directly to ASIC. What I wasn’t aware of, however, is that ASIC then aggregate all this data in a report daily (with a few days lag) which is accessible to the public in a registry here. As such, should an investor that is long a stock be interested in knowing the short-selling trading volumes within it, they can easily search via ticker in this daily report across the 485 reported names. Admittedly, what this report won’t capture are short positions held through a derivative (for example, a swap), but it still is a good source of data nonetheless. By way of example, in looking at the most current file for November 6, the top ten shorts by percentage of total product in issue, are as below:
|Company||Ticker||Reported Shorts||Total Product||% of Total Product|
|JB HI-FI LIMITED ORDINARY||JBH||22344203||114883372||19.44946654|
|SYRAH RESOURCES ORDINARY||SYR||55539916||343603692||16.16394622|
|OROCOBRE LIMITED ORDINARY||ORE||41301246||261409658||15.79943385|
|GALAXY RESOURCES ORDINARY||GXY||62506219||407524024||15.3380452|
|INGHAMS GROUP ORDINARY||ING||48595600||380243196||12.78013664|
|METCASH LIMITED ORDINARY||MTS||109180247||909256748||12.0076367|
|INVOCARE LIMITED ORDINARY||IVC||13121376||110256355||11.90078885|
|DOMINO PIZZA ENTERPR ORDINARY||DMP||9849124||85481140||11.52198485|
|MYER HOLDINGS LTD ORDINARY||MYR||89643694||821278815||10.91513532|
|BWX LIMITED ORDINARY||BWX||13393652||124166270||10.78686829|
In addition to this, and similarly to being long a stock, when releasing an investment thesis or view on the short side a manager does have to disclose whether they have a position in the stock.
Regular readers of the blog would be aware of this through a disclaimer on all our blog posts, and would also be aware that we don’t often share short theses publicly (especially live ones) but may do so with our investors within the relevant strategies through our quarterly or annual commentary.
There are many sound reasons why a manager does not disclose their short-portfolio in full to the market that really centre around disclosure of proprietary information and insights that can potentially have larger commercial implications to the firm both from a trading and reputational perspective.
It should also be dully noted that there is no current obligation for managers of unlisted managed funds to disclose their full long portfolio to the market either. The exception to this is with listed strategies under the form of an Exchange Traded Managed Fund (ETMF) or active ETF’s, such as ASX: MOGL, whereby we disclose our full portfolio to the market quarterly with a two-month lag.
The question of market efficiency
For those that had the pleasure of studying Capital Asset Pricing Models (or CAPM) at University, you would recall, and with perhaps mixed emotions, one of the key assumptions for efficient markets is that the price of securities incorporate and fully factor in all information which is readily available to investors (should you be interested in brushing up on CAPM, you can read more here).
Although at Montgomery we have the view that markets are largely inefficient in light of our fundamentally driven, value-based approach to investing, ASIC believes short-sellers can help market efficiency by providing an early signal that securities may be overvalued.
A common argument I hear against short-sellers is “that they push the price of a security down.” Interestingly, the first thing to note is that not all short-sellers are placing “bets” on the underlying security falling.
In fact, some managers use short-selling for hedging purposes.
Secondly, for those that have a fundamentally driven short thesis, for example like VGI who identified what they believed to be an asymmetry around Corporate Travel’s accounting practices, in actuality they are promoting their views to the market in the same way fund managers and sell-side brokers do when they are long a stock (which, of course funnily enough can cause the share price to go up).
We can look back to a few examples, like Blue Sky Alternatives, to see that having differing view on both sides of the trade can aid price discover and better inform the market.
As a concluding thought, short-sellers don’t always have the success of their investment thesis determinant on the company going broke, it may be as simple as identifying a company as being expensive, structurally challenged, having asymmetries or in some very unique cases, being fraudulent.
In an investment market dominated in Australia by profiting from owning assets outright you may not be in a rush to buy a short-seller on the share market a beer at a social BBQ, but perhaps don’t shy away from a conversation with them to better understand why their view differs to yours!
xiao fang xu
“short selling is a business widely unpopular with everyone who has a stake in seeing stock prices go up.”
“Negative information may not be as valuable as positive information for purposes of cheerleading, but it is just as valuable when people wish to make the best use of scarce resources.”
“Short sellers have been portrayed as heartless opportunists, benefiting from bad outcomes. But they are no different from doctors who profit from our illnesses, or teachers who benefit from our ignorance, or locksmiths who benefit from criminal acts. Further, one’s belief that future reality is more negative than others believe it to be does not change that reality. It simply conforms market beliefs more accurately to it, when short sellers are right — the only situation in which they can profit from their forecasts. Revealing mistakes is socially beneficial, and a far cry from just hoping for bad outcomes (just as parenting sometimes involves deflating children’s false hopes, not to harm them, but to help them make better choices).
What is called short selling in the stock market is common in all sorts of businesses. A farmer who sells on a futures market when he plants, before he has produced his output, does the same thing. So does a homebuilder or custom tool maker producing to order.”
“Contracts and agreements to sell, and deliver in the future, property which one does not possess at the time of the contract, are common in all kinds of business.” There is no reason why a practice commonly accepted in business, which participants must therefore view as beneficial, is somehow harmful to those participating in the stock market.”
“Regulatory opposition also indicates the positive consequences of allowing short selling. Regulatory agencies are supposed to prevent fraud, questionable accounting, and other management misbehavior. However, they often fail not only to prevent, but even to detect them. Short sellers who are betting their own money on being correct often uncover what regulators miss, as they did at Worldcom, Enron, Tyco, etc., showing themselves as more effective market policemen.”
“Dictatorships always immediately ban short selling,” wrote Fred Schwed, Jr., in his fun 1940 book on investing, “since it is axiomatic with them that no professional pessimists are going to be tolerated.”
“To enjoy the advantages of a free market, one must have both buyers and sellers, both bulls and bears. A market without bears would be like a nation without a free press. There would be no one to criticize and restrain the false optimism that always leads to disaster.”
“To enjoy the advantages of a free market, one must have both buyers and sellers, both bulls and bears.” Couldn’t agree more, thank you for sharing your views Xiao.