On the face of it, an investment strategy specifically designed to gain in value when companies fall in value may seem irresponsible. “While it undeniably has its more unsavoury side, short selling can also help manage risk more effectively and contribute to market efficiency. Its reputation is unfairly tarnished by the actions of a few cowboys," she says.
In practical terms, short selling involves borrowing a stock from an investor, and then immediately selling it in the hope that its price will fall and it can be bought back later at a cheaper price. “A profit is realised based on the price decline. At that stage it is returned to the original shareholder, who receives a fee for their troubles.
“It is only when investors take additional steps to influence companies’ financial health and value after they have bought or sold shares that ethical questions arise,” she explains.
As such, to assess the ethics of short selling, Ground believes it is important to consider the actions of different short sellers, rather than short selling as a principle. “In general, those actions reflect their motivations, which can be broadly split into four categories, namely: ‘
“However, the more extreme activist shorters are the ones that give the practice a bad name. Some have been guilty of spreading unfounded and malicious rumours in the press, a consequence of which is that they can earn a profit on their trade but push otherwise healthy companies into financial difficulties. Even if these companies manage to prove the accusations false, the short seller may be long gone by that stage, having booked a profit on their trade and left a trail of devastation in their wake,” says Ground.
“Their emotionally detached nature means they cannot be accused of attempting to drive down prices. It is all about mathematics,” she says.
Considering this, Ground believes that short selling may have an unfairly bad reputation. “Rather than avoiding the practice, investors – especially those who are more ethically minded – may wish to ensure they understand its potential uses in a strategy and how its practitioners intend to behave.
“It can bring about significant benefits, both to investment performance and standards of corporate governance. Although some short sellers are unethical, short selling itself is not. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested,” she concludes.
