Published in July 2014

• Price anomalies in a product can be a result of

• irrational exuberance in a market

• or could also be a by-product of unhealthy companies window dressing or camouflaging their financials.

• Short sellers help the market by not just conducting an in-depth due diligence but by also putting their money where their mouth is.

• Short seller are criticized a lot as enemies who drive down the stocks of supposedly healthy companies and run them to the ground.

• This was repeated far too often in the last decade when the blame for the fall in stock prices of big companies was immediately attributed to short sellers and not to the fact that these firms were simply over-leveraged and poorly run.

Jim Kanos of Kynikos

Associates shorts Enron stock in 2001.

Enron stock falls from $89 to $1 in just over a year

This reflects Enron’s real value in the

market.

Short selling proves to be a good

market feedback system

FACT

• According to a July 2013whitepaper by the New YorkFederal Reserve, it was found thatbanning short selling raised tradingcosts in the equities and optionsmarkets by more than USD 1bnbetween Sept. 18, 2008 and Oct.8, 2008.

• Short selling is primarily driven by market inefficiencies

• The price discovery nature of short selling helps in this case in identifying such overvalued assets and taking advantage of a correction when it happens.

• For an informed investor, it offers a great playing field with a great opportunity of capital preservation while earning higher returns

The high risk and blackjack nature of

short selling can spell doom for those

that fail to anticipate the chance of a

sudden event that could cause a spike

in the price of an asset.

• In a market like India, valuations can get inflated only to tumble down later and see an erosion of even 90% of their value.

• India has seen it with the FCCB boom in 2007-09

• The key, is timing the short properly, both at an market level as well as at the level of an individual stock.

Foreign Currency Convertible Bond

(FCCB)

201 Indian companies raise

USD 16bn

Subsequent wipeout in stocks led to a spree of

defaults

An erosion of around 90% of their value was

seen

• Returns on a short position are capped at 100% of the value of the securitybeing shorted, the downside is virtually unlimited.

• A conservative long position, on the other hand, restricts your overall loss onlyto the initial investment, making considerably more lucrative.

• Moreover, short selling involves a great deal of margin trading which cangreatly amplify the unfavourable swings in the price of an asset, thus leavingyour portfolio with unmanageable leverage.

• The blackjack nature of short selling can also spell doom for those that fail toanticipate the chance of a sudden event that could cause a spike in the priceof an asset. A great example of this is Nokia.

Informed decisions can give returns on short position, that are capped at 100% of the value of the security being shorted

Short sellers started buying back Nokia stocks further increasing their price

Short sellers did not anticipate this, and take significant losses

46% rally in Nokia’s shares when Microsoft Corp acquires Nokia

12% of Nokia’s shares were out on loan by October 2013

Last decade Nokia’s stock falls due to gradually eroding market share

Similarly unrealistically pessimistic outlooks on stocks can run the short selling ship aground before one can say “Ahoy!” A Wall Street Journal report published in December last year talks about how European short sellers got

run over by the bull run in European stocks.

Naked short selling essentially involves shorting a stock or bond withoutactually borrowing the underlying security.

This can cause mayhem in the markets because it leads to a fall in theprice of the asset being shorted even though the short seller hasn’ttechnically closed the deal.

According to George Soros’ principle of reflexivity, naked shorting isbasically an example of how investors’ perception of an asset’s valueaffects that asset’s actual value.

This leaves firms vulnerable to an attack by short sellers purely formonetary gain rather than due to any shortcomings in the financials of thecompany.

1• For a long-term investor, short selling is rather insensible

because of the way the entire process is structured.

2• When stock prices go up short sellers’ losses get higher,

as sellers rush to buy the stock to cover their positions.

3• This rush creates a high demand for the stock quickly

driving up the price even further.

• Short sellers helps the market gain insights into the real value of an asset by performingin-depth due diligence.

• Short selling, therefore, creates a feedback loop in the market thereby discipliningerrant firms that whitewash their financials.

• In addition, if timed well, short selling can be a great means for an investor to ensurecapital preservation while earning significant returns.

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MAECL is not responsible / liable for any losses resulting from such factors.• c. Securities investments are subject to external risks such as war, natural calamities, and policy changes of local / international markets which affect

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DISCLAIMER

Risk factors General risk factors • a. Securities investments are subject to market risks and there is no assurance or guarantee that the objective of the investments will be achieved.• b. Past performance of MAECL does not indicate its future performance. • b. As with any investment in securities, the value of investments can go up or down depending on the factors and forces affecting the capital market.

MAECL is not responsible / liable for any losses resulting from such factors.• c. Securities investments are subject to external risks such as war, natural calamities, and policy changes of local / international markets which affect

stock markets.• d. MAECL has renewed its SEBI PMS registration effective October 14, 2014 and has commenced its portfolio management activities with effect from

January 2011. However MAECL has more than 10 years of experience in managing its own funds invested in the domestic market.

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