“Embrace short sellers” is my message to those who are up in arms over Viceroy’s report and short position in Capitec and here’s why.
The sole purpose of financial markets is to allocate capital between those parties with excess cash (investors) and those companies needing cash. It is neither in the interests of investors nor society as a whole to have capital allocated to businesses that have questionable or unsustainable business practices, or, at a further extreme, have accounting irregularities and/or are scams or frauds. Short sellers help sniff out these companies.
Furthermore, I would argue that short sellers are even more important these days because given the rise in popularity of passive funds, the longer potentially unsustainable operations are left unchallenged, the more of society’s money becomes passively invested in the company.
From 1999-2001, I researched short positions for a South African based hedge fund. We did similar work to Viceroy when researching our short positions, which included African Bank & Profurn. We scrutinised the Annual Reports and accounting policies, secured payslips of employees showing zero take home pay. We spoke to shop assistants and aggrieved customers. We presented our conclusions to some financial institutions. Some agreed with us, some didn’t, we got some shorts right, we got some wrong, that’s the nature of the market. But part of me regrets that we didn’t take a more active stance and notify regulators of the goings-on in the industry back then. African Bank had only R4bn of loans and R3bn of liabilities far less than the R50bn of net loans and R58bn of total liabilities last reported in 2013.
In my opinion, short sellers are the analyst equivalence of investigative journalism and society needs investigative journalists. If those brave sleuths hadn’t exposed the Guptas’ emails, perhaps the “state capture” would still be on-going today. If the investigative journalists at the Boston Globe hadn’t investigated the abusive actions of Catholic priests, perhaps more young children would have been harmed. Short sellers are no different – they go in search of “the truth” and it is surely in the interests of regulators, investors and society to know the truth.
However, they don’t always find “the truth” and sometimes they invent ghosts, expensive ones.
Bill Ackman famously thought he had identified Herbalife as a “pyramid scheme” back in 2012. He bet $1bn that Herbalife would go to $0. The shares sold off but this provided an opportunity for a savvy investor like Carl Icahn to begin building his 26% stake. Herbalife’s share price has since risen 250% from the low and last year Pershing bought back their short position with Ackman losing credibility and his fund investors losing $billions.
For unlike long-only investors who buy shares and are exposed to the potential upside of a share price rising many times over, unless short sellers use fancy derivatives, they can only make 100%. And that’s only if the business goes bankrupt.
This skewed risk / return trade-off, where you can make 100% but lose multiples of your capital, is why sophisticated short sellers don’t normally partake in the short equivalent of a “pump and dump”- why do all that investigative work to only make 10% on the news of your report? No, I think sophisticated short sellers rather go for the jugular or the “home run”, because only then is the risk reward trade-off worthwhile.
We may rely on analysts and fund managers to know every last detail about companies, but in a study conducted between 2003 – 2012 on data requests from the US corporate filings depositary, the average US publicly traded firm had its annual report requested only 28.4 times immediately after filing, a staggeringly low statistic for the annual report, a vital piece of company research.
But then how many Naspers holders have read Tencent’s annual report in great detail and are aware that Tencent is not a Chinese technology company but rather a Cayman Islands company listed in Hong Kong with some “Structure Contracts” with Chinese technology companies that are owned by Tencent’s CEO and original founders, that they disclose, may or may not even be valid in accordance with Chinese laws and regulations?
Viceroy’s tactic of calling for Capitec to be placed into curatorship seems extreme to me, but we should all be free to express to our opinions. Are they anymore guilty of market abuse than the twitter feeds and financial new websites providing a link to their research? People downloaded their research, Viceroy didn’t send it. Viceroy’s report has a lengthy disclaimer at the beginning of their report which says “Think critically about our opinions and do your own research and analysis before making any investment decisions. We are not registered as an investment advisor in any jurisdiction.” Should everyone issuing an opinion on any listed company: newspaper columnists, radio and television interviewees, twitter commentators etc be regulated? Surely not. Viceroy didn’t force anyone to sell their holdings, people sold because they feared their research was right.
But it is also important to recognise that those with conviction that Viceroy’s research was wrong have been given an opportunity to buy at a lower price.
Ironically, the market perhaps now better understands Capitec’s business model after management went to great lengths to dispute and explain the errors they see in Viceroy’s thinking. If the aim is finding “the truth”, surely this debate playing out publicly and transparently is what we all want? I think Resilient and Naspers would do well to follow suit and publicly address the concerns raised in the reports of 360ne and Investec.
I see no difference between a fund manager writing in their monthly newsletter about a company they hold in their fund and a short seller doing the opposite. With one caveat – if short sellers “short and distort”, i.e. spread false rumours and then close positions when the share temporarily falls, that would fall within the ambit of market abuse and regulators should hold them to account.
So rather than shoot the messenger, I suggest investors be open-minded to the work short sellers do. They take a lot of financial and personal risk. They go against all the vested interests and play their part in helping society allocate capital efficiently. They are not always right and if they are wrong, they pay a heavy price.
And if you think they are wrong, any fall in the price gives you a better price to buy more. If on reflection you think they are right, be grateful to them because they may have alerted you to something of which you weren’t aware and have given you get a chance to exit before they score that “home run.”
Unless of course you’re invested in a passive fund in which case you will end up holding the position until the index compiler decides for you.
Sean Peche is the portfolio manager of the Ranmore Global Equity Fund which has no direct or indirect holdings in any of the companies mentioned nor has any connection to Viceroy. Ranmore Global Equity Fund does not short shares.