One of our favorite Jim Chanos interviews is one he did with FT Alphachatterbox in which he explained how short selling provides ‘long-side’ investors with an insurance policy saying:
“Being short with a good short seller who’s producing nominally minor positive returns in a bull market enables you to be more long.”
Here’s an excerpt from the interview:
[Matt Klein] Congratulations. One of the things that seems particularly challenging about short selling, and you mentioned this just now, is that there are a lot of institutional biases against short-selling. The entire sell side industry, much of the financial media, a lot of politicians, they think if things are going up that it’s good. Your 401K is richer.There’s a lot of psychological pressure. You don’t want to be against the crowd. How do you, as an investor, deal with that and be able to on the one hand stick with the position when you think it’s correct, and also not be so bull headed about it that you ignore the conventional wisdom when it’s actually right?
[Jim Chanos] Well first of all, to get to the preface of your question – “up is good and down is bad” – of course while on the surface that seems right we always forget that having Grandma Klein pay too much for stocks can be bad.Short-selling is an important check on the marketplace. In fact Bill Sharpe in his Nobel Prize acceptance speech pointed out that frictionless short-selling is essential for the efficient market hypothesis and the capitalised pricing model. And so it is an essential part of the marketplace, but the trickier part of course is doing it right and doing it well, and that is much, much tougher.
Generally speaking we assume that securities prices over time, in the United States anyway, will generally drift up. That’s the safe bet. But that’s not what you get paid for in my business. So what I’ve always said in terms of the business proposition of a fundamental short seller, and it’s paradoxical, but here we go:
“Being short with a good short seller who’s producing nominally minor positive returns in a bull market enables you to be more long.”
That’s really the essence of what we’re doing. So for example, if I make you a few percent a year being short, in effect I’m an insurance policy. I’m protecting your downside and I’m paying you a small amount in dividends. But think about it. You could then go twice long the market, be short my portfolio, and have 2X the market plus a few percent, minus your cost of the additional carry.
That’s the proposition, and that’s why short selling alpha is so prized in the marketplace when you can find it, because it enables you to be more long. When I tell people that they scratch their head. Here you have a noted bear saying that: My proposition to you is that I’m going to let you be more long.
You can find the entire interview here – Jim Chanos – FT Alphachatterbox.
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