Shorting no longer a sure bet for hedge funds

LONDON (Reuters) - Short-selling, one of the few tactics that made money for hedge funds in 2008, has become a risky bet as prospects for equities have improved, while getting hold of stock to sell is harder as lenders shun weak funds.

Some hedge funds have already changed tactics and are simply buying cheap stocks, wary of getting burned if a stock they are shorting announces unexpectedly good earnings and the share price spikes -- a real possibility in an improving economy.

High-profile hedge fund manager Philippe Jabre told Reuters he had no short positions because it was “too dangerous,” although in future shorting could prove a better trade.

Crispin Odey, founding partner at Odey Asset Management, has also turned bullish on stocks. His European fund has a net long position in equities of 65 percent. “Equities now look exceptionally cheap against cash,” he said.

Shorting -- betting on falling prices -- was particularly effective during the credit crisis for those, such as John Paulson and Lansdowne Partners, who shorted financials.

The strategy isn’t so lucrative now.

James Clunie, investment director in Scottish Widows Investment Partnership’s UK equities team, said: “It’s a little bit harder to find good short ideas right now. Many stocks do look cheap.”

Clunie, who is writing a book on shorting called Predatory Trading and Crowded Exits, said some hedge funds are finding it difficult to adjust to the stock market’s change of direction.


“As a community <hedge funds> seem bereft of ideas right now,” he said. “There’s a lot of activity around rights issues, not on fundamentals.”

Hedge funds have also seen stock borrowing costs rise as institutions become more cautious about who they lend to.

In a normal short, a fund will borrow the stock, often via a prime broker, sell it in the open market and then hope to buy it back later at a lower price.

Last year BT Group Plc's BT.L pension scheme, the UK's largest, halted stock lending citing the risk a borrower could go bust.

“Market conditions meant that there was an increased risk that a counterparty to a stock lending transaction might fail,” scheme chairman Rod Kent said in the scheme’s annual report.

Susan Pike, global head of market products and services at RBC Dexia, said lenders are looking more closely at counterparties and collateral.

“If your fund is in trouble, finding someone to lend to you will be difficult. A year ago there were entities willing to take on almost any hedge fund,” she said.

“Hedge funds can give you equity as collateral, but the question is, what are those equities?”

Short-selling was a controversial tactic last year and was blamed for pushing down share prices, particularly of banks and others financial companies, although stocks continued to fall even after the introduction of a temporary ban.

Since then some hedge funds have benefited from the rise in equity markets since March -- long/short equity funds, which tend to be long-biased, returned 8.21 percent in the first half of 2009, according to Credit Suisse/Tremont.

In contrast, shorting has yielded scant reward. Dedicated short bias -- one of only two strategies to make money in last year’s market chaos -- has lost 10.81 percent so far this year.

Editing by David Holmes