Posted by Peter Molk (University of Florida) and Frank Partnoy (University of California Berkeley), on
Monday, February 18, 2019 
Comments Off on Institutional Investors as Short Sellers? Print E-Mail
Peter Molk is associate professor of law at University of Florida Levin College of Law; and Frank Partnoy is the Adrian A. Kragen Professor of law at University of California Berkeley School of Law. This post is based on their recent article, forthcoming in the Boston University Law Review.
Institutional investors rarely sell short. In Institutional Investors as Short Sellers?, we explore why. We examine how social welfare might be improved if institutions sold short more.
Our core argument is simple: institutional investors obtain negative information about companies, but because they rarely sell short this information is not fully reflected in prices. As an illustrative example, consider three strategies available to a mutual fund manager who regularly obtains a range of information about different companies. It is straightforward for the manager to buy a new position when she receives positive information. Likewise, it would not be unusual for the manager to sell an existing position based on negative information. But if the manager goes one step further, and suggests selling short a company’s shares based on negative information, she likely will face greater resistance. To the extent the fund manager is reluctant to sell short, some negative information becomes “bottled up” within the fund.
Of course, there are some good reasons for institutional investors to avoid short selling. It is costly, risky, and has faced a variety of cultural and regulatory obstacles. These costs and risks of short selling reduce market efficiency. They impose limits to arbitrage that reduce liquidity, increase volatility, and skew the available information about individual companies, thereby leading to less accurate stock prices. When a portion of the distribution of information about a company is limited, because of the various constraints on short selling, stock prices are less likely to reflect the full array of information.
To be sure, not all institutional investors refrain from shorting. Many hedge funds sell short. And not all institutional investors should embrace shorting, given its costs and risks. Nevertheless, we argue that significant social and private welfare gains could result if more institutional investors embraced shorting, both directly, through long/short strategies, and indirectly, by tolerating and encouraging more short selling by asset managers.
In advocating that institutional investors embrace short selling, we suggest that short selling might be viewed in the same way public law scholars view some free speech actors: outlier participants in society who do not represent the views of the majority and who seek changes that would harm certain powerful institutions and individuals, but whose efforts and positions nevertheless can significantly benefit society overall.
The complete paper is available for download here.
FAQs
Because institutional investors are likely to be more sophisticated than the typical individual investor, indirect short-sale constraints are more likely to affect stocks that are owned mainly by individuals. Second, short selling can be costly. Short sellers must borrow shares from an investor willing to lend.
Why do institutional investors short sell? ›
Short selling is a trading strategy where investors speculate on a stock's decline. Short sellers bet on, and profit from a drop in a security's price. Traders use short selling as speculation, and investors or portfolio managers may use it as a hedge against the downside risk of a long position.
Why would an investor make a short sell transaction? ›
Short selling is when a trader borrows shares and sells them, hoping the price will fall after so they can buy them back for cheaper. Shorting can help traders profit from downturns in stocks and protect themselves from losses.
How do investors make money in a short sale? ›
Short selling involves borrowing a security whose price you think is going to fall and then selling it on the open market. You then buy the same stock back later, hopefully for a lower price than you initially sold it for, return the borrowed stock to your broker, and pocket the difference.
What is the minimum size for an institutional investor? ›
Institutional Investor vs. Retail Investor
| Institutional Investor | Retail Investor |
|---|
| Must have over $50 million in assets according to FINRA | No minimum investing requirement |
| Invests as a profession | Invests to fund goals such as retirement |
| Purchases or sales can affect stock prices | Likely doesn't have the ability to move markets |
1 more rowNov 17, 2023
An institutional investor buys, sells, and manages stocks, bonds, and other investment securities on behalf of its clients, customers, members, or shareholders.
Why is short selling unethical? ›
Short sellers have been labeled by some critics as being unethical because they bet against the economy. But short sellers enable the markets to function smoothly by providing liquidity, and they can serve as a restraining influence on investors' over-exuberance.
When should an investor sell short? ›
Typically, you might decide to short a stock because you feel it is overvalued or will decline for some reason. Since shorting involves borrowing shares of stock you don't own and selling them, a decline in the share price will let you buy back the shares with less money than you originally received when you sold them.
How do brokers profit from short selling? ›
Short selling is a risky trade but can be profitable if executed correctly with the right information backing the trade. In a short sale transaction, a broker holding the shares is typically the one that benefits the most, because they can charge interest and commission on lending out the shares in their inventory.
Why would an investor short-sell an ETF? ›
One primary motivation is to capitalize on anticipated price declines in the ETF, thereby generating profits. Additionally, investors might use short selling as a strategy to hedge or offset positions in other securities held within their portfolios.
All of the proceeds of a short sale go to the lender. The lender then has two options—to forgive the remaining balance or to pursue a deficiency judgment that requires the former homeowner to pay the lender all or part of the difference. In some states, this difference in price must be forgiven.
What is the maximum profit on short selling? ›
The short seller hopes that this liability will vanish, which can only happen if the share price drops to zero. That is why the maximum gain on a short sale is 100%. The maximum amount the short seller could ever take home is essentially the proceeds from the short sale.
How much money required for short selling? ›
Short sales require margin equal to 150% of the value of the position at the time the position is initiated, and then the maintenance margin requirements come into play from that point forward.
Do institutional investors sell short? ›
Institutional investors rarely sell short.
Who is the largest institutional investor in the world? ›
Managers ranked by total worldwide institutional assets under management
| # | Name | 2021 |
|---|
| 1 | Vanguard Group | $5,407,000 |
| 2 | BlackRock | $5,694,077 |
| 3 | State Street Global | $2,905,408 |
| 4 | Fidelity Investments | $2,032,626 |
6 more rowsIn that environment, the median institutional investor produced 9.5 percent in annual returns from 2012 to 2021 (exhibit). Institutional investors we interviewed unanimously agree that the current environment is radically different from the global investment conditions of the previous three decades.
Why would someone short sell? ›
Short sellers are wagering that a stock will drop in price. Short selling is riskier than going long because there's no limit to the amount you could lose. Speculators short sell to capitalize on a decline. Hedgers go short to protect gains or to minimize losses.
Why would an investor short a company's shares? ›
Investors use short selling when they feel that a company or sector is overvalued, with a view to profiting when its stock price drops.
Why would an investor short sell an ETF? ›
One primary motivation is to capitalize on anticipated price declines in the ETF, thereby generating profits. Additionally, investors might use short selling as a strategy to hedge or offset positions in other securities held within their portfolios.
Comments Off on Institutional Investors as Short Sellers? Print
E-Mail 