Forget “pump & dump”… boiler rooms of dodgy salesmen convincing poor retail clients that a stock is going to the moon is soo 1980s. This decade is all about “FAKE NEWS” … and as we know, fake news is much more effective when it’s bad, very bad, maybe the worst EVER!

Enough of the Trump references Craig! What do you mean more effective?

The tangible fear response to potentially losing money on something you own is always greater than the equivalent greed response to missing out on something you don’t. The incremental energy required to shake out weak holders is therefore less than that to encourage an incremental buyer. There is a short-term asymmetry that can be taken advantage of.

Wait a minute… where are you going with this? Is this some moral crusade against shorting?  

No no no… I have no problem with short sellers operating in the market and we operate funds at Kames that short stocks. At its best shorting can help push up the cost of capital for unsustainable businesses.  If short sellers uncover the next Enron early, they will do the market and investors a great service. But short & distort schemes do exist and are a bigger issue today than in the past. This is a negative second order impact of the ease with which Information (including misinformation) can be spread these days and this needs to be better understood. Controversy sells and is often thoughtlessly distributed.

But market manipulation is illegal, so bad actors will be caught in the end. Don’t you know *SEC Rule 10b-5? Surely this covers it? 

Ahemmm….. of course I do (*cough*) and there are other rules too. The FCA Market Abuse code is also very clear but proving “intent to deceive” can be very difficult. Market participants can have their opinion (free speech) and are allowed to be just plain wrong (plead ignorance). It is very tough to untangle a story that deploys a web of fallacies. For example, manipulation of factual content that encourages faulty deduction (e.g. red herrings), garbled cause and effect (e.g. conflating timelines or confusing past issues with the business now) or making personal attacks (e.g. unfairly attacking management integrity or suitability) can be layered together.

I get it…. Bad stories are tricky to regulate and prosecute but the truth will out in the end.  Does this not give the smart long-term investor the chance to buy more?

Most of the time yes and we would certainly try to buy such opportunities.  But short ‘attacks’ also create real and often lasting costs for the companies in terms of management time, legal expenses and / or perceived reputational damage. It can impair the valuation for an extended period. At worst, a share price fall can create a “reflexive” negative spiral which triggers debt covenants and takes a perfectly innocent company down.

Ok, you win. But what do we do about it?

No easy solutions. For one, I would welcome a more aggressive stance by regulators against the schemes. We have started to see this happen more in the US as regulators recognise the increasing risk. In the meantime, I guess I’m just reminding investors to be wary of those posing as experts and spinning scary stories. From a sustainability perspective, we try extra hard to protect ourselves against investing in companies which deserve to be shorted. We do this by doing an extra layer of due diligence on every company we invest in. We call this sustainability analysis. We believe it’s an underused method of quality assessment that takes into account strategic product risk, second order impacts, material operational performance risk factors, business culture and governance analysis. At the very least….. it’s all grist to the mill.

About the author

Craig Bonthron is an investment manager in the Equities team, responsible for actively co-managing high conviction global equities portfolios. He focuses on analysing disruptive and sustainable investment trends within the technology, healthcare, industrial and consumer sectors in order to identify high conviction stock specific investment ideas.

He joined us in 2014 from SWIP, where he was an investment director in global equities. Prior to SWIP, he was a portfolio manager at Kleinwort Benson Investors. Craig has a 1st Class honours degree in Building Surveying and an MSc with Distinction in Business Information Technology Systems from Strathclyde Business School. He has 18 years’ industry experience.  *As at 30 April 2019.

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