Cliff Asness: Shorting The Bad Guys

Johnny HopkinsCliff AsnessLeave a Comment

In his latest article titled – Shorting Counts, Cliff Asness responds to the recent Man Group article titled – “Short-selling does not count as a carbon offset. Here’s an excerpt from his response:

What does that mean? It’s instructive to back up and examine how the more traditional non-shorting ESG approach of own less or none of the bad guys can matter to global emissions in the first place. If a significant fraction of the market doesn’t own certain securities (or insists on owning less than their index weights), then other investors have to own more.

You can’t underweight something someone else won’t overweight, or, in econo-geek speak, “the market must clear.”

Now, owning more than you previously wanted to is not riskless as it reduces your diversification. Thus these other (clearly not so virtuous!) investors will demand to be compensated for this extra risk. That comes through the offending firms being priced to a higher cost of capital.

The upside is that this higher cost of capital is what the emitters will have to use to evaluate every possible investment project they contemplate. This higher cost of capital will mean they do, well, less of the stuff we want them to do less of.

Many seem to think not owning the bad guys itself will magically change the world. Well, it does, but it’s not magic, it’s the math that many of us were taught the second week of business school. That is, only pursue projects whose current and future cash flows are “positive net present value” after discounting for time and risk.

By raising the cost of capital, or discount rate, on the bad guys we get them to do less of the bad stuff as fewer of their (bad for the world) projects clear the higher hurdle. This is the mechanism where we actually affect the real world.

Shorting does the exact same thing, only more so. If the virtuous investor is willing to actually sell the bad guys short, the non-virtuous will have to own even more, and the cost of capital goes still higher (even less bad stuff!).

So, while Man Group’s op-ed is accurately titled, as it’s not an “offset,” it’s also quite misleading if taken to mean shorting has no role in the fight to reduce carbon emissions (as, you know, they clearly mean it).

Were that true, it would also be true that divesting from (i.e., owning none or less of) the big emitters, as ESG proponents have done for years, has no role. And that just ain’t so. In fact, it’s quite surprising that there are those who believe you make the world better and better owning less and less of something bad, but that impact mysteriously stops at a zero holding. It doesn’t!

You can read the entire article here:

Shorting Counts – Cliff Asness

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