Fund managers turn gumshoe as forensic short-selling pays off

Asia Plastic Recycling Holding

12/08/2014 14:25

* Tough markets push investors to take more aggressive 
tactics 
    * Forensic hedge-fund index up 17 pct in first half of 2014 
    * Recent successes include Spain's Gowex 
    * Risks of going public include legal action 
 
    By Francesco Canepa 
    LONDON, Aug 12 (Reuters) - Fund managers are increasingly 
turning to investigative tactics, detailed accounting analysis 
and corporate sleuthing in a bid to uncover skeletons in company 
closets that can offer an investment edge in a low-yield world. 
    While billionaire investors such as Bill Ackman and David 
Einhorn have made such tactics famous by respectively betting 
against nutrition group Herbalife  HLF.N  - which denies 
Ackman's allegations it is a pyramid scheme - and Lehman 
Brothers in 2008, the broader industry is now adopting them. 
    Investors say the frustrating market environment - with 
interest rates at rock-bottom and stock markets holding near 
multi-year highs - and an impressive recent success rate from 
investigative hedge funds, which are on course to deliver their 
best returns in years, are pushing them to make deeper dives. 
    "The use of forensic accounting and investigative research 
techniques is noticeably increasing," said Bruce Harington, 
senior analyst at hedge-fund investor Stenham Asset Management, 
adding that investment funds were hiring former forensic 
accountants and investigative journalists. 
    These strategies offer a twist on traditional short-selling, 
which involves borrowing and selling a stock that is expected to 
fall before buying it back at a later date. If the wager was 
right, the price of the shares will be lower, generating profit. 
    What makes forensic short-selling different is that the 
wagers tend to be more aggressive - effectively betting that a 
company is worth next to nothing - and require more resources: 
Bill Ackman, for example, recently revealed he had spent $50 
million on researching his $1 billion Herbalife bet. 
    But a Eurekahedge index tracking four global 
compliance-based hedge funds shows that the broader trend is 
paying off. It was up nearly 17 percent in the first six months 
of 2014, more than five times the average hedge fund and nearly 
three times the MSCI World index  .MIWO00000PUS . The 
Eurekahedge index rose 13 percent in 2013 and 9 percent in 2012. 
     
    RED FLAGS 
    Forensic investors' tactics can involve anything from poring 
over company accounts to using private detectives to gather 
visual or physical evidence that might contradict public data. 
    Short-seller Glaucus Research began probing China Metal 
Recycling  0773.HK  in 2013 after discovering the firm's revenue 
per employee was 11 times more than that of other recyclers. 
    Other red flags included financial statements that did not 
fit with government or industry data, followed by the abrupt 
departure of the group's chief financial officer and the sale of 
shares by the firm's chairman. 
    After Glaucus publicly unveiled its research, Hong Kong's 
securities regulator accused China Metal of exaggerating its 
accounts and is now seeking to liquidate the company. 
 ID:nL4N0FZ2QZ  
    With investment banks cutting back on research coverage, 
hedge funds believe that there are more skeletons out there. 
 ID:nL6N0Q71HZ   
    "There's less and less research being done by banks and 
brokers, and hedge funds have seen this trend as an opportunity 
to jump in and boost their investigative work," said 
Philippe Ferreira, head of research for alternative investments 
at Lyxor Asset Management. 
    These bets are not risk-free: by announcing market-sensitive 
news on stocks they trade, investors who decide to go public 
with their research are vulnerable to legal action. 
    London-listed IT outsourcing services provider Quindell 
 QPP.L , whose shares more than halved after Gotham City 
Research published a report in April questioning its revenue 
model and profit quality, said it had started legal action 
against Gotham.  ID:nL3N0NH2PM  
    Taiwan's market watchdog has also turned against short 
sellers, accusing Glaucus of "spreading rumours" about local 
recycling firm Asia Plastic  1337.TW .  ID:nL3N0NR0HJ  
    A spokeswoman for Britain's Financial Conduct Authority said 
regulated companies can publish research as long as it is not 
false or misleading and they disclose any financial interest. 
The U.S. Securities and Exchange Commission declined to comment. 
    "If we accuse companies of malfeasance, we use publicly 
available information to argue for why the company is actually 
fraudulent or is overstating its earnings," said Sahm Adrangi, 
founder of forensic short-seller Kerrisdale Capital Management. 
    And in tough markets, the rewards have been trumping the 
risks. 
    Spanish Internet company Let's Gowex  GOW.MC  threatened 
Gotham with legal action for spreading "absolutely false" 
rumours at the beginning of July - but the bet paid off two 
weeks later when Let's Gowex filed for bankruptcy after 
admitting falsifying its accounts.  ID:nL6N0PP34W   
 
 (Additional reporting by Blaise Robinson in Paris, Svea Herbst 
in Boston, Andrew Winterbottom and Nishant Kumar in London; 
Editing by Lionel Laurent and Will Waterman) 
 ((francesco.canepa@thomsonreuters.com; 00442075423871; Reuters 
Messaging: francesco.canepa.thomsonreuters.com@reuters.net)) 
 
Keywords: STOCKS HEDGEFUNDS/FORENSICS