Tough Times in Shortsville


An article in today’s Wall Street Journal highlights the difficult market for short investors, a problem which is affecting forensic research firms and other research firms which generate short ideas.  We’ve been hearing from research firms that some short only hedge funds are exiting and the Journal article indicates that short volumes have fallen, making it a tough environment to sell short-oriented research.

As is true of alternative research generally, the short-oriented research firms are a diverse group.  Forensic research firms, which look for indicators of aggressive accounting and other evidence of financial gamesmanship or outright fraud, generally fall into two camps: those that provide deep-dive analysis of a handful of questionable stocks and those that offer quantitative models to flag a broader universe of risky stocks.  In some cases, research firms specialize in a specific sector such as healthcare.

Then you have the firms like Muddy Waters and Citron Research (quoted in the Journal) which short the stocks they bash.  Generally these firms will continue to cover a stock for as long as they have a position.  Currently Muddy Waters is focused on American Tower Corp, a NYSE listed company that manages cell towers.  Citron has been following a broader set of stocks over the summer: USANA, Interoil, Angie’s List.

We even had a hacker-affiliated research firm, Anonymous Research, which made a big splash in 2011 and followed up with research in May 2012, but has quietly taken its website down.

Despite the harsh environment for shorting, some forensic research firms are reporting good results.  Short provider Vision Research, which was founded out of a Harvard Business School Business Plan Competition, says it managed to eke out positive returns during the second quarter as four out of its six high conviction ideas fell despite the bull market.  But the headwinds are strong.

One ray of hope: the SEC under Mary Jo White has targeted accounting fraud as an enforcement priority.  As the SEC’s enforcement division starts bringing accounting fraud cases this may provide a needed boost to the short-oriented research firms.






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