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Longs vs Shorts


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Something I have been wondering lately, is there a predisposition among investors, value investors in particular for going long on investments as apposed to going short. Just from memory it seems that 98-99% of all the ideas discussed on this board are long ideas with a few random short comments thrown in but I don't remember seeing a fully laid out short thesis. Also almost all the investors we admire seem to primarily go long on investments (I can think of a few exceptions to this). My own experience for what it's worth, I have never gone short any investment ever and now I am wondering why that is. Am I predisposed to optimistically think that something will go up and not down? Do I not have the right mental models to think about when and why something will go down and not up? Maybe I just haven't hung out in the right circles ( I spend too much time with you guys :) for me to think about shorting an investment.

 

I would think that "value" investors as apposed to the poorly named "growth" investors would have many of the mental models necessary mental models and would be quick to spot investments that are priced significantly higher then their intrinsic value. So I would expect to see a lot of short ideas on this forum but I see very few.

 

one possible reason that I see and I don't know how to explain the math for this but my fuzzy logic tells me that there are simply more long opportunities out there then there are short opportunities, anyone able to correct my thinking on that?

 

Part of the reason I have been thinking about this is the fact that I am always looking for a niche area to play in. To date I have always played in the nano cap market with a few investments in microcaps because I never felt like I had any edge in the major market companies whose every move is studied by legions of people who are much smarter then I am. So I have played in my small cap sandbox, but recently been thinking about what opportunities there are in going short.

 

 

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In general, companies retain and reinvest earnings. When you are long, this is a tailwind. When you are short, this is a headwind.

 

Most people who short use it to reduce portfolio volatility not generate alpha. For example, Chanos is not expected to outperform the SP500. The people who hire him are using him to hedge their long portfolio.

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In general, companies retain and reinvest earnings. When you are long, this is a tailwind. When you are short, this is a headwind.

 

Most people who short use it to reduce portfolio volatility not generate alpha. For example, Chanos is not expected to outperform the SP500. The people who hire him are using him to hedge their long portfolio.

 

Agreed, good points.

 

Chanos gets paid on relative 'under'-performance vs. the index (If SP is +10% and he is +8%, he gets paid on 2% relative performance). 

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It's natural for there to be a long bias in a rising market.

 

Other factors against shorting.

-It's harder to get the timing right.

-You pay while you wait.

-If your thesis is wrong, your losses aren't capped.

 

"The market can remain irrational longer than you can remain solvent". 

That can apply equally to short sellers or over-leveraged longs.

 

Unleveraged long investors can sit on an underperforming stock and wait it out (maybe getting dividends too).

 

 

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Shorting is emotionally difficult.  Nowadays I am much more comfortable shorting because I keep my position sizing less than 1% (for common shares).  I've figured out ways to find really compelling shorts without having to put a lot of time into research.

 

Most people who short stocks might start their positions with a few percent of their portfolio.  And what invariably happens is that your shorts will go up 2-4X.  Tesla was heavily shorted in the $20s and the borrow was 20% at some points.  Then Tesla went up to $291.  If you shorted 3% of your portfolio in TSLA, this would be very difficult to handle emotionally and financially.

 

2- By my estimate, roughly 2%of American stocks are sold short.  The longs outnumber the shorts by a large margin.

 

3- Short selling is the strategy that I am most comfortable with (and that I've had the most success with).  However, it's dangerous.  It can be a very difficult way to make money.

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There are many reasons for a long bias:

 

1) We generally invest (in stocks) because we have money to buy something with.  We don't normally approach the world from "I have an idea, and I'd like to fund it with a variable inverse-equity loan"?  (maybe we should... but...)

 

2) Shorting is leverage.  Many prudent investors shy away from leverage for obvious reasons (many of those below)

 

3) Shorting is logistically challenging - shorts carry a borrow fee above and beyond the rate of return of the underlying.  Short borrow can be taken away from you at no / limited notice.  The borrow fee can change, etc.

 

4) Shorting is likely very difficult to make profitable *unless* you use short proceeds to buy additional longs.  This introduces basis risk which even for a good short seller and investor could be challenging at times of market distress. (Shorting is often considered a hedge but when short names are crowded, there is actually positive correlation with long / short trades and the market in times of distress)

 

5) Shorting requires use of a margin account, which may be considered higher risk for securities ownership in street name when armageddon comes.

 

6) Skills for shorting successfully and going long successfully are quite different - position sizing, future / present value estimates, etc are very different for long vs. short, and many longs forget this and I think blow themselves up. (for example, A short position where you are wrong grows as a % of your portfolio, whereas a long shrinks.  This probably is the least understood aspect of shorting by those who haven't done it... it makes risk management and averaging down (up) very much different than going long)

 

--

 

I personally don't view Long and Short as two sides of the same coin. 

 

A typical long investment is one where there are many unknowns but even if you don't know / have an opinion, the investment can have a margin of safety (aka, the right price) and you will do ok.  A short is very hard because you may see a business that has what you perceive to be a very slim chance of achieving something amazing, and thus you see it as priced to perfection... however, the buyers of the shares may be idiots buying a story, or they may be very sophisticated investors who have realized that the chance isn't slim, but in fact large... and they are going to make a lot of money off your hubris. Basically, calculating max downside is much easier than calculating max upside.

 

My 2 cents at least.

 

Ben

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Perhaps this is one of those things you need to experience for yourself.  Hopefully you don't go bankrupt in the process.

Shorting Equities sounds great in theory right and is very tempting sometimes - just bet against companies that are overvalued, going bust, etc.  I have a bunch of experience shorting companies and I basically gave it up.  My sum total profits from shorting was positive.  Prior to ~2003 there were frauds that you could short and less hedge funds.  It was still hard making money.  Now there are many more hedge funds and the borrow is tighter plus less acct game frauds.  The game has gotten much tougher basically.  Julian Robertson recently said the same in an interview. 

 

Go look at what happened with VW in 2008 to get an interesting lesson.

You will be wrong a certain percentage of time and it can really kill you.

Lots of time and emotional energy too.

 

Basically shorting is a losers game.  Long term markets go up so if you are a really, really smart short seller and lose -3% a year you still lose.  Plus you have taken on unlimited risk.  Basically I think it is irrational to short equities.  The highly educated, big fund managers are basically stupid for shorting.  The have different reasons for shorting but unless you are making money over the long run, it is a waste of time.

 

 

 

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There are many reasons for a long bias:

 

1) We generally invest (in stocks) because we have money to buy something with.  We don't normally approach the world from "I have an idea, and I'd like to fund it with a variable inverse-equity loan"?  (maybe we should... but...)

 

2) Shorting is leverage.  Many prudent investors shy away from leverage for obvious reasons (many of those below)

 

3) Shorting is logistically challenging - shorts carry a borrow fee above and beyond the rate of return of the underlying.  Short borrow can be taken away from you at no / limited notice.  The borrow fee can change, etc.

 

4) Shorting is likely very difficult to make profitable *unless* you use short proceeds to buy additional longs.  This introduces basis risk which even for a good short seller and investor could be challenging at times of market distress. (Shorting is often considered a hedge but when short names are crowded, there is actually positive correlation with long / short trades and the market in times of distress)

 

5) Shorting requires use of a margin account, which may be considered higher risk for securities ownership in street name when armageddon comes.

 

6) Skills for shorting successfully and going long successfully are quite different - position sizing, future / present value estimates, etc are very different for long vs. short, and many longs forget this and I think blow themselves up. (for example, A short position where you are wrong grows as a % of your portfolio, whereas a long shrinks.  This probably is the least understood aspect of shorting by those who haven't done it... it makes risk management and averaging down (up) very much different than going long)

 

--

 

I personally don't view Long and Short as two sides of the same coin. 

 

A typical long investment is one where there are many unknowns but even if you don't know / have an opinion, the investment can have a margin of safety (aka, the right price) and you will do ok.  A short is very hard because you may see a business that has what you perceive to be a very slim chance of achieving something amazing, and thus you see it as priced to perfection... however, the buyers of the shares may be idiots buying a story, or they may be very sophisticated investors who have realized that the chance isn't slim, but in fact large... and they are going to make a lot of money off your hubris. Basically, calculating max downside is much easier than calculating max upside.

 

My 2 cents at least.

 

Ben

 

Fantastic post.

 

The only thing I might add is that "value investors" tend to also have a favorable bias towards businesses succeeding and generating economic/financial value.  The glaring exception seems to be with companies engaged in fraudulent activities, and it's no accident that the most admired short sell trades -- and they are trades -- are the ones that have ferreted out such fraud.

 

One thing's for sure, though: it's tough to do really well short selling.  The best way to do so is to convince other people that you are so smart and skilled that you are one of the few investment managers that can really add value by shorting/hedging, and to market your product as a part of a balanced investment strategy (similar to Chanos spiel).

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