Maybe you’re an established fund with a large in-house team of research analysts; maybe you’re a start-up in ramp-up mode. Maybe you’re market neutral; maybe you’re strongly directional. One common theme, however, is that your ability to extract Short alpha will be key to your performance. This means that you need a steady stream of Short ideas with sufficient downside in names you can execute, and early enough to avoid decaying alpha or crowding. Are you getting this from your current research providers?
The majority of the sell-side has a tiny minority of recommendations that suggest absolute, or even relative downside in a stock. Certainly far fewer than history tells you will fall or underperform in any given year. Why do they find it so hard to make such recommendations? Perhaps there is a reluctance, or even an inability, to do the necessary work – Short research requires domain expertise in forensic accounting, governance analysis, fieldwork – or perhaps it is down to the conflicts of interest that inherently exist within an organisation that aims to receive multiple revenue streams directly from the very companies it is researching. Either way, this conventional model not only results in a lack of Short content – resulting in inevitable crowding around a handful of consensus positions (a major source of frustration that brings many HF clients to us) – but affects the very character of all content; be it Long or Short. If one doesn’t consider a stock as a potential Short, and kick tyres accordingly; how can one have true conviction in that stock being a Long? A thorough and balanced process should, over time, deliver at least as many Short recommendations as Long – and whilst those that don’t are of undoubted use in many investment processes, e.g. for macro, thematic or sector expertise, company or industry relationships etc; they surely cannot be relied upon as a primary source of alpha on either the Short or the Long side.
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