Dedicated short sellers are a rare breed which has become even rarer in the last five years.

Prompted by a response to our recent post on the very large number of hedge fund liquidations reported by HFR (9,000 over the last decade), we asked the data provider how many specialist shorting funds are still out there. Answer, a mere 17.

The reason, we suspect, is that shorting is hard, particularly when stock markets keep going up, as they have done for the last five years. There is no inherent return to shorting, dividends and the persistent rise in stock values over time means profits are all skill and luck. So shorting on a systematic basis is particularly hard, which may be one of the reasons Long-Short hedge funds have struggled in recent years as well.

Still, current markets might be considered target rich. The market boom has made raising equity capital relatively easy, and there has been the return of valuations based on multiples of sales, rather than actual profits and cash. The mechanisms by which companies can find accounting and other tricks to boost profits also tend to have a finite life: there is only so much a CFO can pull from the drawer.

For instance, here is a chart from Andrew Lapthorne of Société Générale showing the divergence between GAAP and non-GAAP earnings over time, the regulator measure of profits versus the adjusted version many companies present. Note the recent decline in the GAAP measure:

It looks like HFR’s estimates of the assets allocated to the shorters have remained roughly stable at about $6bn over time, even as the number of funds has shrunk. Obviously it makes sense to allocate cash to shorters once the tide starts to go out…

In the meantime, those looking for short ideas should pencil the 4pm sofa chat into their diaries at Camp Alphaville next week, when I’ll be chatting to one of the more notorious practitioners of recent years about the theory and practice of shorting. (July 1 at the Honorable Artillery Company, London, get your ticket here!)

Related links:
Bloody Quindell, Batman – FT Alphaville
Three things long/short hedge funds cannot do (well) – FT Alphaville
Spotting lies, and the lying liars who layer them – FT Alphaville

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