Short Selling by Portfolio Managers: Performance and Risk Effects across Investment Styles

This chapter presents a study to examine the investment performance of portfolio managers who engage in short selling. In recent years, short selling as an investment strategy has moved into the mainstream, with the introduction of many hedge funds and even retail class mutual funds that follow a long-short approach. A short sale is the sale of an asset that the investor does not currently own, in hope of buying it back at a lower price on some future date. Short selling allows the investor to profit from his belief that the price of a security will decline in price. Top-down and quantitative managers mostly use short selling as part of a market neutral strategy, implying that restricting their use of this tool would be detrimental to their performance. This study investigates over 5500 investment portfolios that used short selling between 2002 and 2009 and compares their performance as a function of their investment approach and controlling for the size and investment style. The study finds that prior to recent changes in short sale rules, quantitative managers who used short selling outperformed those who did not, with other managers exhibiting no differential performance due to short selling. However, after the latest short sell regulation changes such as removal of the uptick rule, quantitative managers who use short selling generally underperform those who do not.