Fund managers turn gumshoe as forensic short-selling pays off

Tue Aug 12, 2014 11:53am EDT
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By Francesco Canepa

LONDON (Reuters) - Fund managers are increasingly turning to investigative tactics, detailed accounting analysis and corporate sleuthing in a bid to uncover skeletons in company closets that can offer an investment edge in a low-yield world.

While billionaire investors such as Bill Ackman and David Einhorn have made such tactics famous by respectively betting against nutrition group Herbalife (HLF.N: Quote) - which denies Ackman's allegations it is a pyramid scheme - and Lehman Brothers in 2008, the broader industry is now adopting them.

Investors say the frustrating market environment - with interest rates at rock-bottom and stock markets holding near multi-year highs - and an impressive recent success rate from investigative hedge funds, which are on course to deliver their best returns in years, are pushing them to make deeper dives.

"The use of forensic accounting and investigative research techniques is noticeably increasing," said Bruce Harington, senior analyst at hedge-fund investor Stenham Asset Management, adding that investment funds were hiring former forensic accountants and investigative journalists.

These strategies offer a twist on traditional short-selling, which involves borrowing and selling a stock that is expected to fall before buying it back at a later date. If the wager was right, the price of the shares will be lower, generating profit.

What makes forensic short-selling different is that the wagers tend to be more aggressive - effectively betting that a company is worth next to nothing - and require more resources: Bill Ackman, for example, recently revealed he had spent $50 million on researching his $1 billion Herbalife bet.

But a Eurekahedge index tracking four global compliance-based hedge funds shows that the broader trend is paying off. It was up nearly 17 percent in the first six months of 2014, more than five times the average hedge fund and nearly three times the MSCI World index. The Eurekahedge index rose 13 percent in 2013 and 9 percent in 2012.