Investment Strategies of Hedge Funds

3

Short Selling

You’ll never be the most popular guy at the party if you say the emperor has no clothes.

A hedge fund manager

Remember Hans Christian Andersen’s tale The Emperor’s New Suit, in which all the courtiers strive to please their Emperor, and all are afraid to speak their minds? Can we see this applying to today’s emperors, namely the managing directors of large corporations listed on financial markets?

The hedge fund manager may use this tale to say that people who have a mind of their own and do not go with the crowd may prove rather annoying. In the tale, no courtier has the courage to tell the emperor that he is actually naked, because they all fear they will be considered unfit for their jobs. Today, financial markets are all biased towards good news: if somebody says a company should be sold because it is destroying value, he is not going to be very popular! Short sellers who pin down poorly managed companies are not widely appreciated, but they can be considered the market’s independent voice, and are therefore very important for markets as a warning signal against excesses.

3.1 A BRIEF HISTORY OF SHORT SELLING

This section details some of the important events in the history of short selling, and shows the repeated - failed - attempts to outlaw it.

In his book Devil Take the Hindmost: A History of Financial Speculation, Edward Chancellor suggests that the first case of short selling took place in 1609, when the Dutch merchant, Isaac Le Maire, organized short ...