Stock forum

infinitee00 said:

A Risk which I am little wary about is the fact that it is an actively managed short ETF and not a mutual fund. This means HDGE has to reveal it's positions every day, which can make HDGE vulnerable to market manipulation and short squeezes.

Now this I wasn't aware of and now I've lost interest in the fund. It might be interesting to look at its top 10 holdings regularly but I would imagine that this will make it difficult for the fund to do well. Most actively managed funds only report quarterly and they don't have to disclose short positions.

That looks interesting. I've heard good things about John Del Vecchio. He has a proprietary "Earnings Quality" rating that you can access at Motley Fool if you're willing to fork over the money.

It seems like an interesting concept. Expenses for the fund are a bit high.

As for other ETF's, most aren't actively managed. There are plenty of short ETF's that track the inverse of some index. Many use derivatives to magnify results. You can focus on countries, market cap, and industry as well.

Post edited 11:37 pm – April 16, 2011 by infinitee00

Jae, I actually did put about 2% of my portfolio in HDGE. Planning to buy some SPY or IWM puts if the market goes another 10% higher.

stormam said:

Anyone else have thoughts on weightings? 

One thought might be to factor in short-term interest rates. Higher short-term interest rates would give you a better return on the cash proceeds of the short sale. And there is at least some evidence that inverted yield curve is a good indicator of poor stock market performance:

Looking at the Yield Curve: Time to Reconsider Stock Market Exposure?

Depends on the market really, but I think I end up shorting 3-4 companies a year tops.  I've been successful, but am still terrified of going short!  I want to be really convinced I am right and that the downside (upside for the stock) is pretty limited.  I don't see how DISH stock gets back to $35/shr for example, but even if it did, I would lose 50%.  That hurts, but is not disastrous.  If I could see a scenario where it would go up 100%, I wouldn't short it.  It traded to high 40s in '07 when there were strong rumors AT&T was preparing a bid.  If AT&T, which was deciding whether to build its own TV strategy or buy one (and could justify over-paying for DISH in lieu of CapX), didn't think it was worth $50/shr, I do not see how it gets there on its own. 

My weighting usually depends on what I buy with the proceeds.  I think TKLC was about -7% of my portfolio which I used to fund KKR to a 10% position.   I don't think I would go more than 40-50% short and only then if I really felt the market was over-valued or something huge was being missed…  I've currently only got 15% of my portfolio short and think that is about right for my own view on the market.

Anyone else have thoughts on weightings? 

Post edited 2:03 pm – March 25, 2011 by stormam

The best shorts I have had are not simple to find because each appeared to be a value stock but was instead a value trap.  Personally, I have found by far the most downside protection by shorting these stocks.  Rather than shorting a momentum name like CSCO in 2000 which could increase 50x for no reason, these companies tend to be less followed and in industries people do not like.  As such, if one beats, I lose some but it usually takes a value stock 2-3 quarters of beats before it really breaks out and gets attention.

So, what do I mean and why sell a cheap stock?  I look for dying industries that still have not yet seen meaningful declines in revenue.  High fixed costs are extremely attractive.  For example, businesses like the newspapers, phonebooks, bookstores, etc…  The final stages of a company dying tend to be characterized by high cash flow that lures in value investors and a management team that has been in the business for decades and can not understand how it could end.  Rather than paying large dividends or cutting debt and operating costs, these companies buy back stock and do more acquisitions.  Burning cash on stock is a big plus for me because when you short, high cash flow can be a big headwind if it is used wisely.  It is hard to short the phone companies with 5-9% dividend yields, so I don't.  Building a balance sheet reduces how low the stock can go as well.  When revenue starts dropping, things tend to get bad.  Margins start compressing much faster than people expect.

For example, I shorted TKLC which builds equipment for SS7 networks.  SS7 is the old technology and everything is moving to IP.  SS7 was old and had complicated protocals and needed established software.  IP is new and everyone can compete in this market.  It is hard to rebuild a global network though so companies continued buying SS7 while slowly investing in IP.  The recession helped spur this transition however.  The company traded for 5x forward EV/EBITDA and just missed on earnings, again, and lowered revenue guidance, again.  Numbers came down and it now magically trades for 5x the reduced forward EV/EBITDA.  But it is still a dying business and revenue and margins will continue to fall.  The trick is to have a price target.  I've made decent money here and I used the proceeds from TKLC to buy KKR which has done well.  TKLC could go down more, but risk management is important and I closed it out.

Another example that I just started working on:  DISH.  DISH is a satellite TV company that competes with DirecTV and cable.  It is the low-cost alternative and very popular in more rural areas, but it has a large urban base as well.  Because of things like Netflix, Apple TV, Amazon streaming, TWC offering its shows on the iPad, etc… I think the market is going to slowly move TV distribution over the internet.  It will take time, but it is happening.  A cable company like TWC or CHTR does not mind because it is sells you internet and TV.  If you want your TV over the internet fine, but you have to pay for more internet.  So these companies can help facilitate this transition.  But what happens to a satellite company?  If you start watching TV over the internet, the satellite model stops working.  This was actually highlighted by DISH's CEO Charlie Ergen on the last call who basically said customers aren't worth the value of acquiring them anymore and this business seemed to be going the way of the phone companies.  As such, the CEO is using the company's money to acquire spectrum and other assets looking for things to buy and add on to his existing product before the base is gone.  This could make it a good stock in 5 years, but when he does begin building a new network or product, the stock will get hammered because revenue will start declining while costs are going up => the cheap valuation quickly deteriorates.

Even without the stop loss it was a profitable short screen. So trying out something like:

1) P/S > 1

2) Piotroski 0-3

3) Total Asset Growth > 10% (Can you screen for this?)

4) Price > 5 (Easier to short I'd assume)

5) Avg Volume > 1M (Easier to short/cover)

6) Dividend Yield = 0%

Alternatively if you look at his discussion of Piotroski score, he had negative returns (profitable short) for high P/B (he calls growth) and low Piotroski score. So Maybe just throwing in something like this might work:

1) P/B > 2 (about the top quarter of high P/B stocks when done today)

2) Piotroski 0-3

3) P/S > 1

4) Price > 5 (Easier to short I'd assume)

5) Avg Volume > 1M (Easier to short/cover)

6) Dividend Yield = 0%

I only suggest these as good places to start because Montier's research indicates that these are profitable screens. We could always play with them a bit.

I know a lot about not having much time so I sympatheze

Did you ever check out Montier's criteria? His methodology did the screen and rebalanced yearly which made for a holding period of at least a year (or more if the stocks still met the criteria.) His results were profitable over the period he looks at (1985-2007). He also improved the results by introducing a stop loss criteria. Another link to the article:

Joining The Dark Side: Pirates, Spies and Short Sellers

As a side note, although being profitable is desirable it isn't necessary as a major requirement for all. The main goal for many is to identify underperformance to use in a hedge strategy. If you can identify a class of stocks that underperform you can short them while going long the index (or going long stocks that outperform) and you achieve positive returns regardless of market conditiions (on average).

Post edited 1:51 pm – September 12, 2010 by somrh

I guess I'm more interested in how well the portfolio will do. Do you happen to know the ticker for that drug company example? The drug companies, in general, fit what Montier calls a "story stock" which is what makes them interesting. It's probably not much different than the dotcom story stocks. Some of them did well while the portfolio was crap.

As for your other questions:

"1. What would be a good holding period length?"

I guess it's going to depend on a number of factors. The one factor that is different between short/long is that shorts always count as short-term capital gains. So there's no point in shooting for long for tax purposes.

Having noted that, James Chanos has been sometimes regarded as a "short and hold" sort of investor. This makes sense in the context of the underlying philosophy. After all, we are contending that these companies are irrationally overvalued and that a price correction is due. It may take time for valuations to correct.

According to Graham, the market is a voting machine in the short term and weighing machine in the long term. I don't see why that wouldn't apply here as well.

Whether or not people are comfortable with long-term short positions is a different matter. My emphasis will always reside with the evidence. If the evidence shows that shorter holding periods are better than longer ones I'll go with that.

 "2. What is a good portfolio size for shorting? 10 stocks at most?"

The main restriction you have is your account equity. If you have $1000 of equity in your account (cash/long positions) you are permitted to short $1000 and no more. That provides a clear upper limit.

Some may want to lower that amount to having a different percentages. For example, CSM is an ETF that tracks Credit-Suisse's 130/30 index. They invest 100 in a long portfolio, 30% then gets shorted and the short funds are put into the long portfolio giving that balance.

For an interesting study by Blackstar funds see The Capitalism Distribution

The summary: most stocks are losers. By sheer luck, you should be able to find more underperformers. So I dont' see why there needs to be any restriction on portfolio size other than something more akin to percentage based.