Jim Chanos (Trades, Portfolio) is probably one of the most well-known short sellers on Wall Street. He founded his firm, Kynikos Associates, in 1985 and has been involved in many of the big short-side trades of the last few decades. He was made headlines in the early 2000s with his bet against Enron, and more recently he has been a vocal critic of Tesla TSLA. Kynikos has a total of $6 billion under management, $5.5 billion of which is short only, with the other $500 million deployed long/short. In this interview, Chanos explains how short-selling differs (and how it does not differ) from long-side investing.
Tools of the trade
When it comes to the tools of the trade, Chanos thinks that both long investors and short-side operators need the same things - a solid grasp of valuation and accounting. However, what is markedly different is the mindset of the short seller:
“When we talk about the skillset and the psychological profile of short selling - I used to think they were the same when I first started - I no longer think that. While the actual skill set for looking at companies should be exactly the same, whether you come at something as long or short - you should be analyzing the same kind of ratios, making the same phone calls - I think the psychological, behavioural part of the equation is completely different”.
Chanos believes that the main difference arises because the prevailing sentiment in the market is always in favour of the long investor. It’s human nature to want growth and prosperity and success, and anyone who bets against that is automatically going to receive a certain amount of backlash:
“If you think about Wall Street - it’s a giant positive reinforcement machine. I come in every morning, flip on my Blackberry, check Bloomberg - and of the 100 short ideas that we have in our global fund, I can pretty much confidently predict that there are going to be 20% to 25% every day that are going to have some sort of commentary about it: research reports, analyst buy recommendations reaffirmed, estimates raised, CEO is on Bloomberg or CNBC - and generally it’s noise, there’s not that much informational content in that.
But its positive noise - it's why you should be investing in company A,B,C, or that they’re a takeover target, or that they have some new product. And most people don’t even notice that, because they’re in the business of going long securities. It’s like the music that plays in the background of the investment world.”
We are so used to hearing this positive reinforcement that sometimes we forget that not every single stock is going to be a winner. It takes conscious effort to not get swept along in the general bullishness that has been a fixture of the last eight or nine years.
A difficult environment
“If you’re a short seller, that’s negative reinforcement. You’re being told every morning that one quarter of your portfolio is wrong. And for most people, that becomes a difficult environment in which to think about their investments because it becomes a constant drumbeat of negative reinforcement...It’s why a lot of really really good investors are not good short sellers.”
If you are an investor who is long only, and think that these words have no application to your investing life, you should reconsider. After all, there is nothing principally different between Chanos taking a short position on an overvalued stock, and a prudent value investor who sees that that stock is overvalued and chooses to stay out altogether. The short sellers are just more aggressive, but the analysis is principally the same.
So even if you think you will never be on the short side, do take a minute and consider what the consequences of this ubiquitous positive reinforcement are, and spare a thought for people like Chanos who seek to inject a modicum of rationality into our exuberance.
Disclosure: The author owns no stocks mentioned.
