• Greenshorting is a method used by ESG fund managers to influence company behaviour
  • The practice is said to have more impact than shareholder activism 
  • We ask whether the practice of shorting is ethical in the first place

 

A recent study by Boston-based State Street has found evidence of ‘greenshorting’, a phenomenon where investors borrow shares of companies with a weak sustainability profile, and sell them at a profit when the price falls.

More and more, ESG portfolio managers are beginning to short stocks that have a higher carbon footprint, while buying those with lower carbon and good return averages.

Fundies such as Plato Investment Global Net Zero Hedge are reportedly actively engaged in green shorting.

Hedge funds like AQR, which boasts some of Australia’s biggest super funds among its clients, has also used short-selling as a way to mitigate climate risks across their portfolios.

AQR has outlined three reasons why short selling would make sense in an ESG-focused portfolio.

“First, shorting may be a great way for portfolio managers to express their investment views,” said Cliff Asness, the founder and Chief Investment Officer at AQR.

“Second, shorting may be a great way to hedge risks, including those of an ESG nature.

“Third, many ESG-oriented investors seek impact through their financial portfolios.

“Impact is never easy, but the most realistic case by far for affecting the real economy is holding a large position in an issuer, voting shares, engaging, and maybe even getting a seat on the board,” Asness said.

 

Greenshorting vs shareholder activism

Essentially, short selling creates an immediate impact on companies by dissuading them from pursuing whatever is objectionable to the community in general.

And companies hate to be shorted, just ask Elon Musk about his disdain for short sellers.

Others say that short selling has the potential to help reallocate $50-$140 billion of capital away from the most heavily polluting companies.

Founder of hedge fund HITE Asset Management, James Jampel, believes that greenshorting plays a more powerful role in forcing companies to reduce carbon emissions than shareholder activism.

“It may work better than shareholder engagement because it allows investors to avoid the conflict of interest that arises from holding long positions in ESG laggard companies,” he said.

Jampel says the problem with shareholder activism is that investors with long positions have a fiduciary duty to make money from rising stock prices.

As a result, those investors are less likely to support ESG policies that would lower the company’s valuation.

“You really cannot, without a conflict of interest, advocate for significant government intervention in carbon markets with a long-only portfolio,” Jampel said.

 

Is short selling ethical?

For ethical investors, the biggest question remains : is short selling ethical in the first place?

Short selling does have a bad reputation and in Australia, it is illegal for individual traders to short sell.

Schroders’ Head of Strategic Research, Duncan Lamont, says that while profiting when companies fall in value might not seem particularly responsible, short selling can also help manage risk more effectively and contribute to market efficiency.

“There are no blanket answers to questions of the ethics of short selling,” Lamont said.

“In our view, the pertinent question is less whether short selling is ethical and more how investors behave, whether in expectation of price rises or falls.”

Lamont added that short selling can indeed bring about significant benefits, both to investment performance and standards of corporate governance.

“Some short sellers are unethical, but short selling itself is not,” he said.

Elizabeth Pittelkow Kittner of GigaOm agrees, saying that while short selling itself is a standard stock market practice, not all short selling can be considered ethical.

“Some short sellers may act unethically in a scheme known as “short and distort,” which happens when someone takes a short position and then uses a smear campaign to attempt to influence a decline in the stock value,” she said.

“The opposite of that would be what’s popularly known as “pump and dump,”, which is when someone buys stock and then spreads fake news to the public in an attempt to influence an increase in the stock value.

“These types of unethical schemes have become more popular over time as more people—specifically more small investors—gravitate to online trading.”

 

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