Going over to the dark side to sell stocks short is usually the preserve of sophisticated institutional investors and hedge funds, but Wall Street, ingenious as ever, has devised an easy way for the masses to try to make money betting against companies.
The vehicle is the Active Bear ETF, a portfolio of companies two money managers believe are likely to become stock market dogs. The ETF trades on the New York Stock Exchange, and gives investors one of the few ways to participate in an actively managed holding of shares sold short.
The fund is the brainchild of two experienced short sellers, John Del Vecchio and Brad Lamensdorf, who take the opposite tack from most money managers. Normally, money managers scour the investment landscape looking for companies deemed likely to succeed. The pair instead spend their time looking for poor prospects likely to tank.
Mr. Del Vecchio admits it takes a quirky personality, especially attuned to misfortune and even skulduggery, to take a shine to this line of work.
“When I walk into the office every day, I would rather find the company that I think is going to go down 30 per cent than the company that’s going to go up 300 per cent,” he says. “I like kind of being the detective that finds somebody with their hand in the cookie jar.”
Short selling is the opposite manoeuvre from the normal action of stock buying, or “going long” as it is called. In a short sale, an investor sells stock borrowed from a broker, hoping to buy it back later at a lower price and close out the transaction. If the stock falls, the investor pockets the difference as profit; if the stock rises, the investor suffers a loss.
Stock indexes tend to rise over time, suggesting that short selling is a game for losers, but Mr. Del Vecchio says overall market up trends mask a huge number of companies whose stocks do poorly.
He points to research from Blackstar Funds that found during the 1983-2007 U.S. bull market, one of the strongest rising market periods on record, two out of every five stocks had negative total returns and nearly one out of five lost at least 75 per cent. The overall gain for market indexes was driven by the one out of five stocks that had advances of better than 300 per cent.
For Mr. Del Vecchio, the figures mean that even as markets rally, plenty of stocks actually go down.
The Active Bear has been around for a little more than a year and has a market capitalization around $170-million (U.S.). Proving its worth during a down spell, it soared nearly 30 per cent after markets peaked last May and declined into the fall during the European sovereign debt jitters. But as the markets have recovered since then, it has given back all of its previous gains, and then some.
Mr. Del Vecchio says the market is being artificially inflated by such actions as the Federal Reserve Board’s money creation program, known as quantitative easing. These efforts, he contends, “are just going to lead to bigger disasters down the road.”
Meanwhile, he says sentiment is at a bullish extreme, while the number of S&P 500 stocks in up trends is around 83 per cent, an extreme level suggesting shares are at least temporarily overvalued and due for a correction. “The market is very overbought,” he said.
Stock selections in the fund are based on corporate weaknesses that could lead to lower stock prices. Among them are such factors as high leverage, poor industry outlooks, “aggressive revenue recognition” and rising receivables.
Currently, the fund has 44 positions. The biggest is OpenTable Inc., a restaurant reservation service, followed by Goodyear Tire The fund shorts mostly medium- and smaller-sized firms, but has taken positions against a number of household names, including Citigroup , Tiffany , Best Buy and Deutsche Bank .
There are no precious metals or resource stocks in the portfolio. Mr. Del Vecchio says commodities are in a bona fide bull market, so he is staying clear of them. As well, he’s avoiding shorting the big U.S. multinational stocks that have been on a tear, such as Apple and Google.