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Confessions of a Short Seller

Posted By Barry Ritholtz On May 17, 2008 @ 9:43 am In Psychology,Short Selling,Trading,Valuation | Comments Disabled

Nice Interview [1] with my pal Doug Kass, the "anti-Cramer" in this week’s Barron’s, called "
Confessions of a Short Seller

Doug runs a short only fund, Seabreeze Partners. He discusses a few key datapoints from the interview:

• As of April 30, flagship Seabreeze Partners Short fund was up 16.5% (vs 5.6% loss for the SPX)

• Since inception (January 2005) the fund is up 40.7%, versus a 15% gain for the S&P

• The amount of trading dollars that are in dedicated short pools are tiny:  About $5.4 billion (Knowledge@Wharton). That’s one-seventh the size of Fidelity’s Magellan Fund.

• The $5.4B dedicated short hedge funds are a sliver of the nearly $2 trillion of hedge-fund assets.

• Over the past two decades, 58% of the issues on the New York Stock Exchange have advanced, while 42% have declined — every year.

Here’s an excerpt from the Interview:

What makes short selling so difficult to do effectively over a long period?

The objectives of a long buyer and a short seller are similar. Both want to produce uncommon returns by taking common risk — typically by developing a variant view. Many believe short selling is a mug’s game, but I don’t, and thus far our results at Seabreeze have supported our opinion. But it is essential to maintain a disciplined short-selling strategy because, remember, risk and reward are asymmetric in selling stocks short. An investor can make only 100% if correct — that is, if the stock sold short goes to zero. But you can lose an infinite amount if you’re wrong as the stock keeps appreciating. And there is a gravitational pull of stocks higher over longer periods of time. So we use a very conservative approach to shorting.

Explain it, please.

First, we’re diversified across company and industry lines. No individual security exceeds 2.5% of our partnership’s assets and no industry sector exceeds 20% of the assets. We’ll have 35 to 40 holdings at any given time. Second, "Wee Willie" Keeler, a .341 lifetime hitter who played in the early part of the 20th century, liked to say he "tried to hit ‘em where they ain’t." We try to do the same by being creative in our stock-selection process.

In what ways are you creative?

We strenuously avoid stocks whose short interest is high relative to the float, or companies whose shares have large short positions relative to their average daily trading volumes. Many short sellers have made the mistake of shorting valuation and have blown up during short squeezes. Avoiding them allows us to sleep at night and allows time for our negative fundamental catalysts to develop.

We also mitigate risk by avoiding leverage [borrowing to enhance the size of a position]. Historically, short sellers have taken concentrated positions, often in companies with small to medium capitalizations, and then used — and abused — leverage. That’s a recipe for disaster, particularly when they select investments with too many shorts. The average market capitalization of our holdings is more than $10 billion. Shorting large-caps is another way to control risk.

Interesting stuff . . .


Confessions of a Short Seller
Interview With Douglas A. Kass, President, Seabreeze Partners Management
Barron’s May 19, 2008

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[1] Interview: http://online.barrons.com/article/SB121097996687000019.html

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