This article was published in Spanish in Trader Secrets in January 2013
Let's talk about the best short positions to finance your longs and reduce the volatility of your preferred long term bullish investments. In a market where investment recommendations are predominantly positive, where stock market corrections are considered anomalies and upward moves are deemed "fundamental", where the mantra of "do not fight the central banks" is almost religion, we forget that this bullish macro environment provides fantastic opportunities to generate alpha with shorts.
As I'm sure you will be tired of bullish recommendations, "value opportunities" and "everything is discounted" messages, today we will talk about shorts.
As a friend of mine says, in a hedge fund making money with longs is work, making money with shorts is pleasure. And regarding short positions there is a not-surprising widespread myth: it is not easy to find long term shorts because the risk is asymmetric. That is because even when one finds a Lehman or a Bankia it cannot fall by more than 100%, but stocks can rise much higher.
This is true, but we forget that the role of a short position is not exactly "to go down", but to finance a long position and reduce volatility. And once you have found that stock you love, where you see a huge potential but also a high level of volatility and a significant risk, you can fund that position with a good short. Do not surrender to beta and close your eyes.
In Europe it is rare to find minority investors that finance their long-term good ideas with short positions, but here in the UK or the United States it is very common, and learning to mitigate volatility is part of the success of investment, whether as an individual or institution, especially in a market where moves are exaggerated, violent and very short term.
That's why the best thing you can find in the world are those gems of shorts that tend to behave worse than their peers over the years.
Forget the ECB, the BoJ, the Fed and the Bank of England. There is a very clear reason why certain companies in selected sectors such as semi-state owned electric utilities, telecommunications, some integrated oil companies, construction and concessionaires tend to under-perform their indexes: value destruction through the investment process. Companies spend money to generate lower returns.…
