Amid the chaos the GameStop Corp (NYSE: GME) saga has brought upon the investing world, some people have asked: Does shorting even work?
After all, don't share markets head up in more years than they head down? In the medium to long term, doesn't the market drift upwards?
Shorting might be a way to make a quick buck off a declining business – but it's mostly a losing strategy against other companies, said Frazis Capital Partners portfolio manager Michael Frazis.
"We've noted before that when bearish investment professionals heavily short a widely loved company, the love tends to win out," he wrote in a memo to investors Monday.
"This has happened time and again across our portfolio with Tesla Inc (NASDAQ: TSLA), Afterpay Ltd (ASX: APT) and Carvana Co (NYSE: CVNA) et al."
The GameStop short squeeze has ruined the reputation of funds that short, according to Frazis.
"Long/short funds may never be the same. Certainly, institutions should think twice about allocating pension money to long/short funds that did not perform in the crisis of 2020; and can toast billions of dollars in days with a single misjudged trade," he said.
"It's a familiar irony that long/short strategies sound like sensible risk-managed approaches, but so often prove the opposite."
And he should know. Frazis used to short.
Image source: Frazis Capital Partners
Why Frazis gave up shorting
The Motley Fool asked Frazis why he and his fund stopped shorting a couple of years ago.
There was a moral reason.
"Shorting changes your mindset. It brings out your cynicism. You do well when others do not," he told The Motley Fool.
"Every company has a team of people working hard to make it a success. It's infinitely more rewarding to spend your days being positive and supportive of other people."
But above all, according to the Sydney fund manager, it's not a winning strategy.
"It costs a fortune to run a short book. Shorts can cost 2% to 4% to hold a year, and sometimes a lot more," he said.
"We plan to be in business for 30 years, so that adds up to a staggering amount. The real money in life is made by owning successful businesses for extended periods of time."
No winners in GameStop debacle
GameStop, believe it or not, became a now-famous target for activist investors because more than 100% of its shares were shorted.
That means there could've been some "naked" shorting going on, which is a short investor selling a share that they hadn't actually borrowed.
This is illegal in both the US and on the ASX.
While no one (except for the fund clients) is going to shed any tears for hedge funds that lost money, Frazis warned ultimately no one will win out of this episode.
"It's important to remember that all short squeezes end in the same way: a collapse in price. Once the forced buyer folds at the top, there is no reason for anyone else to buy," he said to investors.
"Having said that, this may not be over. The memes and use of language over the past week has been second to none."
What it has done is to shed light on some new "heroes" in the investment world.
"There are 7 million people on [Reddit group] r/wallstreetbets. If they have US$5k each, that's US$35 billion of dry powder. That's more than enough to push around a heavily shorted stock."
GameStop shares pushed up another 68% on Saturday morning Australian time, to hit US$325. It was US$17.25 a month ago.
