Short selling is not unethical – whatever the world’s biggest pension fund tells you

Norihiro Takahashi, president of Japan's Government Pension Investment Fund ©: Shoko Takayasu/Bloomberg via Getty Images
Norihiro Takahashi, president of Japan’s Government Pension Investment Fund

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People have a problem with short sellers. I’m not sure why this is.

Maybe it’s a market-wide manifestation of the notion: “if you can’t say anything nice, don’t say anything at all”.

Maybe it’s because most people are long, and so the number of people who want prices to go up is always much bigger than the number who want prices to go down (which is how short sellers make their money).

Or maybe – as with so many things finance-related – it’s just plain old ignorance.

In any case, now the world’s biggest pension fund is trying to turn it into an ethical issue.

How to make money from shares going down

Short selling is the art of making money when a share goes down in price. If you’re “long”, you are betting a share price will go up. If you’re “short”, you’re betting it will fall.

How do you do that? Take a company whose shares are trading at £10. You think it’s going to come out with an unexpectedly bad set of results, and the share price is going to fall to £8. How do you profit?

You borrow the share from someone else who owns it, and tell them you’ll give it back after a set period of time. You sell the share at £10. You now have £10, but you owe someone a share.

The company’s results come out. You were right, they’re terrible. The share price dives to £8. You buy the share back and return it to its rightful owner. You now have £2 profit. Clever you.

“Wait a minute there,” I hear you say. “Why would I – a ‘long’ investor – lend my share to this horrible short seller who does not share my opinion on the marvellous prospects for this company?”

Well, the reason you’d do that, is because the short-seller pays you a fee for borrowing the share. In other words, you get paid for renting it out.

More to the point, as a ‘long’ investor, maybe your time horizon is different. Maybe you’re happy to sit on the share for five years, whereas this person wants to make a bet on the next six weeks.

The short seller is willing to pay you rent on a share you hold for the long term, in exchange for the privilege of expressing their short-term market view. That sounds like a good deal to me. That sounds like – I don’t know – a functioning free market?

When Elon Musk applauds your corporate governance

And so we come to the meat of the story. The world’s biggest pension fund – Japan’s Government Pension Investment Fund (GPIF) – has jumped on the ESG (environmental, social and governance-focused) bandwagon along with everyone else.

Now, according to the FT’s Leo Lewis and Billy Nauman, the fund has decided that it will no longer lend the overseas shares held in its portfolio to short-sellers. The fund owns about $733bn in equities, and about half of those are invested overseas. So, as the FT’s Lex column puts it, “that is a big bite”.

And the thing is, as the FT points out, the GPIF was making about $150m a year from lending out these shares. It’s not a huge amount in the context of the overall portfolio, but at a time of negative interest rates, any positive return stream – especially a risk-free one – can’t be sneezed at. So this isn’t cost-free.

So what’s the rationale here for sacrificing the free money? GPIF is apparently worried about the governance bit of the ESG. You see, if you’ve loaned a share out, you don’t know what the end user is going to do with it. And you also lose the voting rights while you don’t hold the share. That stops you from “exercising proper stewardship over the underlying investments”.

In other words, in a world where big funds are increasingly expected to make the effort to pay some attention to what company boards are doing rather than just playing golf all day, allowing your shares to be loaned out to short-sellers isn’t a good look.

But as the FT writers point out, this is quite a lame excuse. You can make sure you get the shares back for any key votes, for example. It’s not hard to do.

Instead, I suspect that this is just yet more lazy corporate virtue signalling and greenwash, taking the place of genuinely grappling with tough issues.

Just to be clear, I don’t have any special fondness for short selling – it’s not something private investors can easily do without spread betting (which is wildly risky in itself) and it’s probably not something most of you really need to concern yourselves with.

But given that opinions make a market – including the opinion that a share price should be a lot lower than it currently is – the constant eagerness on behalf of those in power to get rid of shorting strikes me as a very bad idea.

The reality is that short selling is a pretty thankless job. You have to not only get your figures right, but you also have to get your timing right. That’s hard. One recent academic paper from fund manager Robeco even argued that it was basically a waste of time (though I’d expect that to get a lot of push back).

And – surprise, surprise – you tend to find that the managements who yelp loudest about being targeted by short sellers are also the ones who could really do with the scrutiny.

There are lots of arguments on the topic – but to close for today, for anyone who might still be thinking that there is something genuinely “icky” about short-selling, reflect on this: in response to the story, Tesla CEO Elon Musk tweeted: “Bravo, right thing to do! Short selling should be illegal.”

I don’t know about you, but if I had Elon Musk praising my corporate governance, it would give me pause. It’s like having Sweeney Todd admire your shaving technique – or your shortcrust pastry.