Skepticism comes at a price: The tough realities of short-selling
Betting against the market is not for the faint-hearted. Reflections on Hindenburg founder Nate Anderson's heartfelt farewell letter...
In an unexpected development shaking the financial world this week, Hindenburg Research, a well-known short-selling firm that has taken on titans such as Carl Icahn and Gautam Adani, announced its shutdown.
Short-selling is a polarizing trading strategy — there are strong arguments in support of (market efficiency, fraud detection, risk-hedging, etc.) as well as against (malicious manipulation, short-termism, exacerbating volatility, etc.) the practice. Unsurprisingly, responses to Hindenburg’s shuttering were incredibly varied, ranging from glee and amusement, to respect and sadness:
While the nature of his profession is controversial, Hindenburg founder Nate Anderson’s farewell note really moved me, where he made heartfelt comments about the stressful nature of short-selling and the impact this had on his life:
“It has also been rather intense, and at times, all-encompassing. I often wake up from my dreams because I’ve thought of a new investigative thread to pull on in my sleep, or an edit that clarifies a point I didn’t realize I was troubled by during the day. Or from the general pressure of it all. We are not fearless—we just have faith in the truth and hope it leads us down the right path… I probably could have had it all along had I let myself, but I needed to put myself through a bit of hell first. The intensity and focus has come at the cost of missing a lot of the rest of the world and the people I care about.”
Clearly short-selling is not for the faint-hearted. Rather than debating the merits or short-comings of the practice, I wanted to outline three key reasons why I believe it’s more challenging to build an enduring investing career as a bear vs being a bull in the market:
Uncapped downside potential: Stocks can go up infinitely, but the lowest price a stock can ever get to is $0. So unlike a long position where losses are capped when the stock hits the floor, short positions have an unlimited ceiling on potential losses. Furthermore, stocks can go up indefinitely. So even if a short-selling thesis is eventually proven to be right, very smart investors have learnt the hard way that the market can stay irrational longer than short sellers can stay solvent. For the most part, Hindenburg seemed to have a high rate of success on their calls:
Higher carrying costs: Short selling involves “borrowing” a stock and then selling it, in the hopes that the share price will subsequently fall such that the investor can then repurchase (i.e. “cover”) the stock at a lower price to return to the lender. The investor pockets the price difference as profit in the process. Not only are short transactions oftentimes more complicated compared to long positions (where an investor owns a stock), they can be more expensive as well due to various fees. Shares usually have limited lending supply — for instance, some shares are not loanable by default except in particular margin accounts, or supply can be reduced in situations where institutional owners have mandates against lending out stocks. These dynamics can lead to elevated lending fees that eat into returns. In fact, Acadian Asset Management has found that the cost of shorting a stock is now at historic highs which could make this an unattractive investment strategy for driving outsized returns:
“As of 2024, we routinely observe annualized shorting costs above 100% for hundreds of individual U.S. equities, and we occasionally observe stocks with costs above 1,000%. We haven’t seen anything like this since 1931… Perhaps someday, shorting a stock will be as simple as buying a latte. Until that blessed day occurs, we must survive in a dystopian system with hundreds of horrendously overpriced stocks, but nothing much that anyone can do about it.”
Stigma and emotional burden: In principle, short sellers are betting on the decline of an asset in order to make money. This dynamic of profiting from someone else’s misfortune (remember “The Big Short” of the subprime mortgage crisis”?) can create tensions from a societal perspective. Rooting for failure rather than success is not often the norm. As a result, short sellers can be viewed with vitriol, become vilified, and have few allies. As Anderson noted in his farewell letter, short sellers often face intimidation through means such as litigation. There have also been cases where retail investors have rallied against short sellers to “squeeze” them.
From investigating corporate misconduct and fraud (such as in the case of Enron) to tempering fads (such as during the dotcom bubble), short sellers play an important role in a well-functioning financial ecosystem. As a VC who sits more in the “bull” camp, I have immense respect for those who chose to undertake short selling as a profession, especially the “bears” who do this work well and in an upright manner. Higher downside risk, higher costs, higher psychological stress… all of these factors can lead to quick burnout for short sellers, but I hope that investors build on Hindenburg’s work and continue to take on this worthy and necessary endeavor.
what kind of saas content is this? :P