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Short notice - Why you ought to pay attention to the recent comments of a famous short-seller

05/02/2014

Andrew Lyddon

Andrew Lyddon

Fund Manager, Equity Value

We last met Jim Chanos on The Value Perspective when we piggybacked his great experience – and success – in shorting the shares of overvalued businesses to run through Five signs your stock could be a value trap. This time he has caught our eye following an interview with Reuters, in which he said he was seeing a lot more opportunity in the market for his company’s short-only hedge fund.

When one of the world’s most successful short-sellers switches his attentions from the long-short hedge fund he and his company have, over the last five years or so, been most actively putting in front of investors to their short-only offering, we would suggest it is worth taking notice. Many market participants, however, have apparently been less than impressed by this change of focus.

Chanos told Reuters he had been drawing criticism from people who maintain the outlook for equities is so good that there could not possibly be any short ideas out there. To his mind, however, the market is now “primed for short-sellers” such as him and, as a result, he is now going out to raise capital for his short-only fund.

 “Markets mean-revert and performance mean-reverts and even alpha mean-reverts, if at least my last 30 years are any indication,” he told his interviewer. “And the time to be doing this is when you feel like the village idiot and not an evil genius” – that last phrase being a reference to a nickname he has earned over the years as a result of his looking to profit when businesses fail.

As developed equity markets continue their broadly upward trend, this seems a pertinent comment for investors to bear in mind – and it is certainly one with which we, as value investors, can empathise.

After all, if we stay true to the value methodology, which is shown to work over a long period of time, then there will inevitably be occasions when we do start to feel a bit uncomfortable.

Hopefully it does not reach the point of scouring the job ads for a village with a vacancy for an idiot but it is natural for all investors to question sometimes whether they are doing the right thing. Yet, based on what history tells us about how performance works, it is exactly when you feel most stupid that you have to stick to your guns and, ultimately – long or short –  you will be rewarded for doing so.

Chanos’s assertion to Reuters that he is finding more shorting opportunities across the market is an indication he thinks a number of company valuations are becoming less sustainable and obviously, while that is a chance for him to profit explicitly, equally it may be seen as a warning signal for long-only investors to pause for breath rather than getting caught up in the frenzy of the wider market.

 “Be fearful when others are greedy and greedy when others are fearful,” Warren Buffett famously observed. Today, a lot of long investors are growing greedy – thus “priming the market” for short-sellers like Chanos. None of which, of course, is to say the market cannot continue to rise and cause anyone who chooses to go short rather keep their powder dry in cash a considerable amount of pain.

As another famous financial quote – this time from John Maynard Keynes – reminds us: “the market can remain irrational longer than you can remain solvent.”

Author

Andrew Lyddon

Andrew Lyddon

Fund Manager, Equity Value

I joined Schroders as a graduate in 2005 and have spent most of my time in the business as part of the UK equities team. Between 2006 and 2010 I was a research analyst responsible for producing investment research on companies in the UK construction, business services and telecoms sectors. In mid 2010 I joined Kevin Murphy and Nick Kirrage on the UK value team.

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