Responsible investing’s latest tool: The Big Short.
Some innovative investors are adopting a sophisticated Wall Street trading tool to “green their stock portfolios.” It’s called short selling — that is, to invest against which way you think the stock market is going. It’s a strategy many of us first learned about through The Big Short, a film focused on the sources of the 2008-09 financial crisis. The “shorts” in that story who placed bets against mortgage-backed securities came off as smarter and more clear-eyed about investing than most of the global financial community.
But shorting a stock has always had an aura of something not quite right. This is partly due to its association with the catastrophic financial meltdown, and partly because of its contrarian stance i.e. betting that stock prices will fall, rather than rise. The strategy can also backfire in spectacular and unforeseen ways in bull markets. “Never the most popular camp on Wall Street,” the Wall Street Journal wryly notes.
In case you’ve forgotten your lessons from The Big Short, here’s what short-seller investors do: They “borrow” shares from a broker and sell them, hoping that the prices fall; then those shares can be repurchased at lower prices. If this sounds counterintuitive, it is. Some see it as almost un-American to bet against the future prospects of a company or an economy. But others see the tactic as an important part of market discipline.
That the trade has a contrarian, vaguely disreputable tinge makes it all the more interesting that some pioneering investors are promoting shorts as a constructive way to raise the green quotient of stock portfolios and help combat global warming.
One of the highest-profile proponents is Cliff Asness, one of Wall Street’s savviest value investors. The founder, managing principal and chief investment officer at AQR Capital Management, says taking short positions against stocks with high carbon emissions is a compelling way to convey an investor’s views on objectionable management policies. “Shorting dissuades companies from pursuing whatever is objectionable to the short community — in this case, carbon emissions,” he argues.
“Shorting dissuades companies from pursuing whatever is objectionable to the short community — in this case, carbon emissions.”
Pioneering climate investor Chris Ito, CEO of asset manager FFI Advisors, thinks so as well. “We think they’ll open the market up for alternative strategies like hedge funds to be more impactful.” Short positions, he says, can facilitate more shareholder engagement of high emitting companies by challenging those firms to perform better on climate-related issues that impact the value of the firm.
The most high-profile example of the strategy was activist hedge fund Engine #1’s shorting of Exxon stock as part of a strategy to pressure Exxon on carbon emissions.
But shorters can go both ways. If they think ESG strategies are hurting a company, they are ready to bet against an ESG-friendly company. This happened recently when some hedge funds made bets against Vestas and Nordex, two European wind turbine manufacturers. They have also bet against Beyond Meat. And Allbirds is now one of the most heavily shorted U.S. stocks.
How can such a strategy square with the long-term interest that is generally promoted as integral by sustainable investments?
One answer to this concern has come from new standards to harmonize short selling with ESG: the Global Principles for Sustainable Securities Lending. The Global PSSL issued revised and updated guidelines last fall that provide “a holistic and unifying market standard aimed at promoting good governance, transparency and responsible working practices.”
Useful guardrails for sure. But the ultimate arbiter on whether companies will survive in a new post-carbon age will be their ability to convince investors they have the right business strategy for the right time. Whatever you make of short selling as an investment strategy, get used to it.