23/04/2009 - 00:00

ASIC ban on short selling makes no sense

23/04/2009 - 00:00


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Australia’s ban on short selling financial stocks defies logic and the proof is readily available.

AUSTRALIA remains the only country in the developed world to maintain a regulatory ban on short-selling 'financial' stocks, which make up 30 per cent of our market.

Short-selling, which in simple terms means selling stocks you don't own, is designed to reduce volatile speculation; yet an examination of a sample of stocks reveals their performance since being protected has been abysmal: Goodman Group (down more than 80 per cent), GPT Group and Futuris (down 65-70 per cent), Macquarie Group and Wesfarmers (down around 30 per cent).

What is it that the Australian Securities and Investments Commission knows that no other regulator in the developed world does?

When ASIC extended the ban to the end of May, it said that it "weighed up the continued volatility in global financial markets and potential damage from aggressive or predatory practices from short selling against the possible loss of some market efficiency or price discovery.

"As well as conducting its own extensive research and analysis, ASIC has also had the benefit of input from other regulators and from a wide cross section of market participants in reaching its decision," the regulator said.

Yet, how does that match with the view of the chief of the UK Financial Services Authority, Hector Sants, who said: "we remain firmly of the view that long-term shorting is an absolutely legitimate investment technique and it generally contributes to market quality."

He goes on to say that the UK's recent temporary ban on short selling was "about breaking the linkage between share price movement and consumer behaviour, not about market volatility."

Across the Atlantic, Kathleen Casey, a commissioner of the US Securities and Exchange Commission, says the bans actually increased volatility and diminished liquidity.

"We do know, based on review of the SEC office of economic analysis as well as studies and feedback from both academics and market participants, that the short selling ban created significant disruptions and distortions to the markets," she says.

Perhaps the cruelest blow for company bosses came from Martin Wheatley, the chief executive of the Hong Kong Securities and Futures Commission, who regularly receives calls from corporates saying "my price is going down, it is the short sellers again.

"Now because I have data I can usually say no, it isn't," he says.

"It is people selling the stock. They are not selling it short, people are just selling it. Corporates don't really like to hear that, but most of the time it is the truth."

I cannot think of a single well-managed, adequately capitalised company with a sound business model that has failed due to short sellers.

Typically, prices plummet for any number of reasons - poor management, over-hyped concepts, debt-fuelled creative accounting through to fraud and deception.

It is in these circumstances that short sellers actually benefit the market.

There is a case to be made that they have a better track record of uncovering malfeasance than regulators, auditors and the media.

Profit is a powerful motivator, and as legendary short seller Jim Chanos says, the best of the short selling brigade are "real time financial detectives."

Chanos is one of them. While presiding over Kynikos Associates a decade ago, he was the first to target the false profits and prophets of energy giant Enron - a house of cards built on fraud, deception and the worst in corporate governance.

Enron was an evil company that had its demise accelerated by short sellers who, in the process, actually saved the hard-earned savings of many people. Unfortunately, not all Enron investors.

Beware the companies, their auditors and the bureaucrats policing compliance; I can think of no better real time monitor than highly motivated and researched short sellers who have their capital at risk.

Yet the perception remains: short sellers destroy companies, distort and manipulate markets, have no legitimate role and are too risky for a portfolio with fiduciary duty.

All this against the reality that short selling is the dominant strategy used by hedge funds which are now generating profits, as standard investment practices succumb to the ailing global economy.

The Australian market has been decimated over the past year - the ASX200 down 41.9 per cent, and with an indicated high level of risk at 19.8 per cent standard deviation.

The picture is the same on global equity markets.

In the same timeframe, though, short biased hedge funds have made substantial profits - up 22 per cent, and with much less risk at 13.75 per cent standard deviation, according to Hedge Funds Research Inc.

Measured over the past five years, the story is the same. Short biased hedge funds have returned more than 8 per cent at a risk deviation of 9.65 per cent, while the ASX200's annualised return has been negative 0.5 per cent at risk of 14.7 per cent.

Other hedge funds with a balance of shorts and longs, or some shorts, have also outperformed the traditional markets with less risk.

The facts dismiss the fears and validate the essential place short selling has in a fiduciary-responsible, diversified portfolio.

Yet I have sat across the table from asset consultants and superannuation trustees discussing various hedge fund strategies such as those included in Harvard University's endowment portfolio ($US45 billion under management at June 30 2008), only to be viewed with suspicion.

There is a lack of understanding that hedge funds are not an asset class, but a legal structure representing a range of risk/return outcomes.

And when markets are falling, or a stock is discovered to be over-priced, one way to protect your investment, or make money, is to short sell.

Dare I be argumentative and say it is irresponsible for trustees and advisors not to include a short component in their portfolios, particularly in today's environment.

Come May 31, we can only presume that logic will prevail and ASIC will remove the ban on short selling financial stocks.

After all, in the words of Kathleen Casey, "I hope that in the future we can fine tune our responses to market events, minimise potential collateral consequences of our actions and make decisions based on facts and data and not as concessions to fear."

If we can't, I will console myself by re-reading a few more chapters of Extraordinary Popular Delusions and the Madness of Crowds. After all, it sometimes seems that little has changed since Charles Mackay first published it in 1841.

But then again he was debunking witch-hunts, crusades and alchemy, not short selling.

n Jon Horton is founder, director and managing partner of NWQ Capital Management Pty Ltd, a fund of hedge funds operator based in Perth. He has 20 years of experience in asset management in Australia and the US



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