* Tough markets push investors to take more aggressive
* Forensic hedge-fund index up 17 pct in first half of 2014
* Recent successes include Spain's Gowex
* Risks of going public include legal action
By Francesco Canepa
LONDON, Aug 12 Fund managers are increasingly
turning to investigative tactics, detailed accounting analysis
and corporate sleuthing in a bid to uncover skeletons in company
closets that can offer an investment edge in a low-yield world.
While billionaire investors such as Bill Ackman and David
Einhorn have made such tactics famous by respectively betting
against nutrition group Herbalife - which denies
Ackman's allegations it is a pyramid scheme - and Lehman
Brothers in 2008, the broader industry is now adopting them.
Investors say the frustrating market environment - with
interest rates at rock-bottom and stock markets holding near
multi-year highs - and an impressive recent success rate from
investigative hedge funds, which are on course to deliver their
best returns in years, are pushing them to make deeper dives.
"The use of forensic accounting and investigative research
techniques is noticeably increasing," said Bruce Harington,
senior analyst at hedge-fund investor Stenham Asset Management,
adding that investment funds were hiring former forensic
accountants and investigative journalists.
These strategies offer a twist on traditional short-selling,
which involves borrowing and selling a stock that is expected to
fall before buying it back at a later date. If the wager was
right, the price of the shares will be lower, generating profit.
What makes forensic short-selling different is that the
wagers tend to be more aggressive - effectively betting that a
company is worth next to nothing - and require more resources:
Bill Ackman, for example, recently revealed he had spent $50
million on researching his $1 billion Herbalife bet.
But a Eurekahedge index tracking four global
compliance-based hedge funds shows that the broader trend is
paying off. It was up nearly 17 percent in the first six months
of 2014, more than five times the average hedge fund and nearly
three times the MSCI World index. The
Eurekahedge index rose 13 percent in 2013 and 9 percent in 2012.
Forensic investors' tactics can involve anything from poring
over company accounts to using private detectives to gather
visual or physical evidence that might contradict public data.
Short-seller Glaucus Research began probing China Metal
Recycling in 2013 after discovering the firm's revenue
per employee was 11 times more than that of other recyclers.
Other red flags included financial statements that did not
fit with government or industry data, followed by the abrupt
departure of the group's chief financial officer and the sale of
shares by the firm's chairman.
After Glaucus publicly unveiled its research, Hong Kong's
securities regulator accused China Metal of exaggerating its
accounts and is now seeking to liquidate the company.
With investment banks cutting back on research coverage,
hedge funds believe that there are more skeletons out there.
"There's less and less research being done by banks and
brokers, and hedge funds have seen this trend as an opportunity
to jump in and boost their investigative work," said
Philippe Ferreira, head of research for alternative investments
at Lyxor Asset Management.
These bets are not risk-free: by announcing market-sensitive
news on stocks they trade, investors who decide to go public
with their research are vulnerable to legal action.
London-listed IT outsourcing services provider Quindell
, whose shares more than halved after Gotham City
Research published a report in April questioning its revenue
model and profit quality, said it had started legal action
Taiwan's market watchdog has also turned against short
sellers, accusing Glaucus of "spreading rumours" about local
recycling firm Asia Plastic.
A spokeswoman for Britain's Financial Conduct Authority said
regulated companies can publish research as long as it is not
false or misleading and they disclose any financial interest.
The U.S. Securities and Exchange Commission declined to comment.
"If we accuse companies of malfeasance, we use publicly
available information to argue for why the company is actually
fraudulent or is overstating its earnings," said Sahm Adrangi,
founder of forensic short-seller Kerrisdale Capital Management.
And in tough markets, the rewards have been trumping the
Spanish Internet company Let's Gowex threatened
Gotham with legal action for spreading "absolutely false"
rumours at the beginning of July - but the bet paid off two
weeks later when Let's Gowex filed for bankruptcy after
admitting falsifying its accounts.
(Additional reporting by Blaise Robinson in Paris, Svea Herbst
in Boston, Andrew Winterbottom and Nishant Kumar in London;
Editing by Lionel Laurent and Will Waterman)