James Chanos, President of Kynikos Associates, whose fund accounts for 90% of institutional short funds in the US, delivered a very well-thought out keynote at last week’s Investorside research conference, on “Independent Research at the Crossroads.”
He has $2.9b under mgmt. And there’s only $3.3b in institutional shorts overall. So has >90% of the market.
It’s best for me to speak after lunch because my talks are “unsettling but not nauseating.”
Independent research is a cottage industry, with low barriers to entry. Flexible.
Is free speech not protected in bull markets?
Forces of darkness:
*soft dollar concerns
1985: he’s had private detectives go thru his garbage.
1983: critiqued Waste Management Inc. Said it was accounting spam. The (size XL) CFO told him, ‘This is a small town, OK?’
Owen Lamont at yale has done great research on this, showing that the more an issuer intimidates, the worse their underperformance later.
2 current cases:
Organized plaintiff’s bar is now looking into the short selling business, which is bad news for independents.
Keep your business in federal not state courts…they’re much friendlier to free speech than state courts.
Hedge funds are only 5 -10 percent of equity value worldwide, but could be 20-40 percent of trading volume.
50% of total hedge fund dollars are from fund of funds, and as much as 80% to 90% of inflow in last 2 years. Given the 2 layers of fees, Fund of Funds will soon pull back.
FORCES OF LIGHT
*sell side backsliding
Investment banks are again hyping stocks. You can’t legislate fear and greed.
Level of sell side research in EU is “laughable”. Kynikos just opened office in UK; they only have 2 indie vendors in UK that they use.
Jeff Skillings in his testimony in the Enron trial said, “I threw down a piece of independent research (from an Investorside member) and said, ‘They’re on to us.’.” You, the independent research industry, should market this story! This is the greatest PR the industry could have.
His lawyer said: “securities fraud is trading on, or inducing others to trade on, info you know to be false.” That’s a definition he’s comfortable with.
A WORD ON ‘NAKED’ SHORT SELLING
This is the allegation that hedge funds, in cooperation with indies, are conspiring to destroy companies. As opposed to companies doing a poor job of managing themselves.
It is illegal for a US investor to sell short a stock that it hasn’t borrowed. The exception is for market makers engaged in legit market-making activities.
Where do “failure to delivers” a shorted stock come from? From broker-dealers.
There’s a suit now against a broker-dealer inquiring why the fund (who sold short) is being charged large negative rebates, given the broker-dealer wasn’t naked. This is an important suit that is being followed closely.
Never let Washington regulate you after the fact.
He’s active in the Coalition of Private Investment Companies. We ignore
Washington at our peril.
Indie research is a great story that needs to be told, and sold.
Q: What metrics should a short look at?
A: Mgmt. has gotten more sophisticated about what to hide….what metrics shorts are looking at.
Land partnerships at homebuilders is ‘across the line’. They have huge hidden leverage. top 5 homebuilders had bigger ROE than google last yr….that’s not sustainable. Many homebuilders are disintegrating fast.
Historically Kynikos’s best trades have been value stocks. They looked cheap….all the way down.
Recommended book: ‘Accounting for Growth’. he gives it to all his new analysts.
Teten: why aren’t there more institutional shorts?
* it’s no fun. Months of pain punctuated by a few hrs of pleasure.
* wrong psychologocal makeup. Many smart investors are very poor short investors.