Short Selling

Short Selling & Hedge Funds

Last week I got a Hedge Fund Group related email from a head of a short selling focused research firm. I have exchanged several emails with him regarding short selling research and realized I had not written much about short selling hedge fund strategies or trends here in my blog.

The first hedge fund created was labeled so because each long position was hedged with a short position, this is often called a "pair trade" or "matched pair." Today in the hedge fund industry many hedge funds still hedge each position in some manner, but many other hedge funds do not short sell securities or hedge all of their positions. This is due to several factors, two of the most prominent being the:

• Migration of some long-only equity managers into hedge fund vehicles, where their skillset is in building portfolios of long positions
• Expansion of the definition of a "hedge fund." Now some real estate and private equity like investment groups are labeled hedge funds less because of hedging and more because of their fee/payout structure.

A portion of the managers who are using short selling within their portfolios are still moving up the learning curve on profitably taking these positions. This is because many came from a long only world and usually try reverse engineering their long only strategy to come up with shorting ideas, some more successfully than others. For example being in early on a great long idea can prove very profitable within a long only portfolio where moving in too early on a great short idea can lead to great losses, the timing is more critical. Some long/short managers I have seen are 90-95 percent net long and don't have very many meaningful short positions built into their portfolios. Some of this may be by design but a portion of it is simply due to the experience and skillset of the portfolio management team at the hedge fund.

Another less common short selling strategy is to find companies beginning to or likely to be involved in fraudulent activities. This is where a hedge fund manager will seek out publicly traded companies who are trying to cover something up, prevent poor press exposure or delay the announcement of a negative news event.

Read dozens of more articles like this within my Hedge Fund Strategy Guide.

- Richard

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