Short Circuit II
Shorted Out
zdnet.com
The most famous victims of the bull market, however, are probably the feshbach brothers - Kurt, Joe and Matt - who were notorious in the 1980s for their attacks on companies they didn't like. They threw in the towel in the middle 1990s.
A celebrated hedge fund manager who quit earlier this year was Julian Robertson, whose Tiger Management was short on several billion dollars of technology stocks when Robertson pulled the plug, according to HedgeWorld, a service for the hedge fund industry. "The current technology, Internet and telecom craze . . . is unwittingly creating a Ponzi pyramid destined for collapse," Robertson reportedly wrote to his clients in March just before he announced the closing of the fund. This turned out to be unfortunate timing for his investors; he closed it only weeks before the Nasdaq collapse.
Another well-known short who pulled back is Michael Murphy. In September, he merged his Overpriced Stock Service (OSS) newsletter in with Short On Value, a letter published by Will Lyons, that recommends using shorts as a hedge on long investments. Short On Value has been in business since 1992.
OSS began publishing in 1983 and focused on technology stocks. It featured Murphy's scathing comments on companies he believed to be overvalued and analysts whose work he did not like.
When OSS stopped publishing, Murphy closed short positions in Ariba, Bottomline Technologies, Broadcom, Critical Path, Microsoft, Multex.com, Sybase and Veritas Software. Ariba was his worst short, a 50 percent loss in a couple of months. But he said he made money on five of his other seven shorts.
One celebrity short who's still in business is James Chanos, who runs Kynikos Associates in New York. At 24, Chanos made his name in 1984 for uncovering the scandal about Baldwin-United, an insurance company that went bankrupt after its fraudulent practices were confirmed, and withstood criticism from the Wall Street firms that were touting the stock, including Merrill Lynch.
But short selling has changed. Short sellers are no longer able to "badger stocks" the way they could two decades ago, said Charles Gradante, chief investment officer at the Hennessee Hedge Fund Advisory Group, a New York consulting firm. Information is too readily available and shorts cannot take large positions that expose what they're doing, he said, which is why their funds have shrunk to less than $100 million from $500 million, according to sources.
But hedge funds still use the practice extensively, especially long/short funds, which own some shares and short others. CSFB Tremont said that these funds were up 5.27 percent through the first three quarters of 2000, after a 47.23 percent gain last year. The number of all kinds of hedge funds has grown 648 percent during the last decade.
Why short stocks? Plainly because shorts see some stocks as being overvalued. Paul McEntire, chairman and managing director of Skye Investment Advisors in Los Gatos, Calif., and manager of the BearGuard Fund, is a Stanford Ph.D. who worked on the Apollo space program before becoming a money manager. Shorting can be useful for hedging long-term investments, he says, although "as a stand-alone business it is not very interesting." McEntire's fund, which began in November 1999, was down 5 percent through early November. But from March 9 until April 14, when the Nasdaq fell 34.2 percent, it was up 33.5 percent, and from Sept. 1 to Oct. 12, it rose 28.7 percent, while the Nasdaq dropped 27.4 percent.
If short stock has a negative correlation with a long - a share that an investor owns - it can offset a price decline in the long stock. An investor who has shorted a stock also receives rebate interest from his broker and he may realize a capital gain. "That is a valuable investment," McEntire said. "You are not putting out any extra money; you are earning maybe an extra 12 percent and you are reducing the risk to your portfolio."
Shorts make a mistake if they sell a stock just because its valuation is too high, said Hennessee's Gradante. They have to find some event and short a stock just before or immediately after that event occurs. "You would not put a short on Cisco just because it has the second largest market cap behind GE," he said. "Cisco could be the GE of tomorrow."
McEntire spread his investments in the BearGuard Fund over 75 stocks, none equal to more than 1 percent of the value of the fund. "I would love to have a 5 percent short, but you have to protect against the one in 1,000 chance that a stock will triple, double or quadruple."
The fund likes to hold shorts for three to five years and has shorted one stock for 11 years, McEntire said. That company is CopyTele, a Long Island firm that, on its face, seems like one that could have been invented by short sellers. Founded in 1982, the company still describes itself as a start-up. It has virtually no revenue or earnings and is a favorite of shorts.
Though some might call McEntire one of those ghouls or vultures, he talks more like a Ph.D. And as the manager of a public fund, he tries to avoid any appearance of actively seeking to damage a company's stock price. He does not campaign against companies or spread negative stories, he said, but will talk candidly about their valuations and their business models. In fact, his past comments about Amazon being overvalued sound a lot like those being made now by most mainstream security analysts.
Lyons said people who blame short sellers for driving down the price of stocks or the market have it all wrong. "There aren't enough shorts to make the market go down," he said. "People who say that might as well blame the surf because there are waves." Nor does he have patience for the idea that short selling is unchristian. "I can't imagine any greater waste of capital than investing in a Web company that has a $30 billion value and no business," Lyons said.
Six to nine months ago was a great time to short technology stocks because so many were so overvalued and had such flimsy business plans, he said. It is still possible to short, and even safer, because stocks are unlikely to suddenly run up 20 percent to 40 percent in a month, Lyons said.
Even Wade - after his initial and dramatic outburst against short sellers - concedes they have a place in the investment world. "Maybe if the shorts were around this unbridled run-up would not have happened. But a lot of these stocks have gotten so high, they are too high to short," he said.
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Short Circuit
Regulating The Market
James Spitzenberger, a chip designer for LSI Logic, dabbled in short selling this year, lost money and now wants the Securities and Exchange Commission to tighten the rules governing the game.
Spitzenberger said he "over-allocated" his money when he shorted another semiconductor maker and a toy company last spring. The semiconductor stock ran up when an analyst touted the company, costing Spitzenberger thousands of dollars.
That experience moved him to send a letter in response to the SEC's December 1999 request for comments on possible changes to Rule 10a-1, which regulates short selling. Every day, Wall Street market makers short initial public offerings, sell short on down ticks and short stocks for which they don't have certificates. They do it, Spitzenberger said, even to stocks their own firms are recommending.
Complaints about market makers are common among the hundreds of letters sent to the commission. Letter writers said shorting stocks that are not listed on the exchanges or the Nasdaq National Market System - i.e. the Nasdaq OTC Bulletin Board, Small Caps and Pink Sheets by market makers - is common. The SEC lacks the authority to regulate shares that are not traded on an exchange. The National Association of Securities Dealers' (NASD) rule mimics 10a-1.
Spitzenberger admitted in an interview that he had shorted IPOs himself by trading through offshore exchanges.
Shorting an IPO within 30 days of the offering is forbidden by the SEC, as is shorting a stock when its price is falling.
In requesting comments about changing Rule10a-1, the SEC said exchanges and self-governing bodies such as the NASD already use sophisticated surveillance tools to monitor market activity. Short selling, the SEC noted, is integral to trading baskets of securities and is instrumental in sophisticated investment models such as hedging options positions and arbitrage.
The commission asked for feedback on a number of items, including what price should be used in shorting stock in after-hour trading, the possibility of eliminating the uptick rule and what the reporting requirements should be for brokers who short. The uptick rule limits investors to shorting only when the price is rising. The SEC worries that if that rule were eliminated, market professionals could manipulate stock prices at the expense of nonprofessionals.
The Island ECN, an electronic communications network that gives investors access to the market, advocates abolishing parts of the rule. There is no market rationale for regulating short selling, said Chris Concannon, associate general counsel at Island. It simply inhibits downward price movement, he argued, while there is no inhibitor on upward movement. He also said there is no evidence that the lack of rules for OTC and Small Caps have led to abuse.
Concannon said Island backs changes dealing with after-hours trading, modifications to the uptick rule and excluding some actively traded securities from regulation because surveillance can detect manipulation of these stocks. |
