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Global markets are nervous and investors fear that a big correction in the stock market will finally come. When it finally does, who will be making money? Short sellers, that’s who.

What exactly is ‘going short’? In essence, it is when an investor speculates on a drastic drop in a stock price. The difference between the price at which the shares were initially sold and the price at the time of repurchase is the earned profit.

Short strategies can be difficult for private investors to conceptualize. They are almost always engaged in long strategies, meaning that they buy shares expecting that prices will rise. Therefore, the notion that an investor can also make money when prices are falling, is a complete reversal in their customary logic.

The reality is that long/short strategies have become dramatically prevalent over the last 13 years. But that doesn’t mean the public has started seeing this strategy in a different light. Specialised short sellers continue to struggle with a bad reputation, which is largely a residual result of the economic crisis. During that period, short sellers were seen as – at best – ‘vultures’.

The most famous example of (successful) shorts is referenced repeatedly, thanks in large part to Hollywood. Investor Michael Burry was portrayed in 2015’s ‘The Big Short’, making millions of dollars from the collapse of the American housing market during the financial crisis. Burry was speculating that derivatives on mortgage loans would plunge, and he was right. Then you have fictitious characters like Bobby Axelrod portrayed in the TV series ‘Billions’, whose wildly successful hedge fund depends largely on insider information in order to short specific stocks at the right moment.

Damian Lewis as Bobby Axelrod in “Billions” Source: Showtime

Regardless of a less than pristine public image, asset managers may be warming up to short strategies. This was evident during a recent Alpha Research Investment Meeting on alternatives, where it was reported that hedge funds reached a new peak in assets last July, exceeding $3.2 trillion under management.

Magnus Spence (Jupiter), was empathetic during the investment meeting. “Short selling continues to run against basic human behavior: to sell something you don’t own, which is mathematically unattractive. The upside is 100%, the downside is unlimited. Oh yes, there is always the risk of a short squeeze if shorter sellers run to the exit at the same time.”

But he contended that it is possible to benefit from three “bubbles”, essentially anticipating shorts related to shifts in:
1) growth to value stocks
2) US to European stocks
3) Passive investments to active management

Now, while the strategy remains wildly unpopular, is the right time engage in it. Don’t wait for equity markets to correct, because by then, the rest will already have jumped on the band wagon.