Investing during the coronavirus: moral outrage is misplaced

Coronavirus has wreaked havoc on international stock markets in recent months, but some investors – think short-sellers, hedge funds, bargain-hunting value investors – are doing just fine. Many commentators have an instinctive dislike at the idea of people profiting in a time of crisis, but is this little more than misplaced moral outrage? Short-sellers, who profit when markets decline, are invariably condemned as immoral speculators in times of financial crisis, so it wasn't surprising that Italian populists called for a ban on the practice as indices plunged in mid-March. "It is not tolerable that someone takes advantage of a national emergency by speculating to the detriment of Italian savings," complained former deputy prime minister Matteo Salvini, the leader of the anti-immigration and Eurosceptic League party.

That view was echoed by other Italian politicians, including Giorgia Meloni, leader of the hard-right Brothers of Italy, who called on regulators to ban "financial speculation from bringing the nation to its knees".

Consob, Italy's financial market regulator, heeded those calls, with short-selling now banned until June. Other countries have followed suit, with short-selling restrictions having been introduced in France, Spain, Belgium, Austria and Greece.

“Speculative short selling can fuel market turbulence and lead to considerable risks”, said Austrian financial market regulator FMA, who said its temporary short-selling ban “has proven to be unavoidable, effective and appropriate”.

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The European Securities and Markets Authority (ESMA) has also defended the measures, although other European countries – including Germany and the UK – have opted to steer clear of such a ban. Britain's Financial Conduct Authority has said it sets a "high bar on imposing any bans", saying short-selling supports effective price discovery, enhances liquidity and enables investors to manage risk. The US, too, has allowed the shorts to keep shorting. Days after Lehman Brothers went bankrupt in September 2008, the Securities and Exchange Commission (SEC) banned short-selling of financial stocks, with then SEC chairman Christopher Cox saying it would "restore equilibrium to markets". Three months later, a basket of financial stocks had almost halved in value, prompting Cox to admit: "Knowing what we know now ... [we] would not do it again. The costs appear to outweigh the benefits."

Dim view

The differing approaches might indicate that evidence is mixed regarding the merits and demerits of temporary short-selling bans. In fact, studies almost invariably take a dim view of the idea.

Banning short-selling brings "no benefits" and various "ill effects", including decreased liquidity, higher trading costs, and a higher likelihood of corporate fraud, cautioned a 2011 paper from the US Federal Reserve. It concluded that short sellers "are unpopular because they deliver messages that people would rather not hear".

In 2012, Federal Reserve Bank of New York research into the short-selling restrictions introduced in 2008 and 2011 concluded the bans had “little impact on stock prices” and had the “unwanted effects of raising trading costs, lowering market liquidity, and preventing short-sellers from rooting out cases of fraud and earnings manipulation”.

A 2018 paper, Short-Selling Bans and Bank Stability, went further, saying bans were actually associated with higher volatility and a higher probability of default.

Markets “may have read the imposition of bans as a signal that regulators were in possession of more strongly negative information about the solvency of companies, and especially banks, than was available to the public”, the paper concluded.

A 2013 paper published in the Journal of Finance, Short-Selling Bans Around the World: Evidence from the 2007–09 Crisis, was similarly unenthusiastic. It ended by quoting Cox on the costs of short-selling bans outweighing the benefits, adding: “It is to be hoped that this lesson will be remembered when security markets face the next crisis.” That crisis has come, but the actions of European regulators indicate this lesson hasn’t been learned.

Alternatively, it may be that they are well aware that short-selling bans are at best ineffective and at worst counterproductive (besides concerns about liquidity and trading costs, professional investors complain that banning shorting makes it more difficult for them to take long positions, as they cannot hedge their risk). Nevertheless, restricting shorting gives the impression that they are not standing idly by, that they are taking action in a time of crisis and preventing unholy speculators from profiting in a time of crisis.

Ackman says his actions "were no different than a home owner buying flood insurance"

To many, it "feels" wrong to profit at times such as this, as evidenced by the criticism recently meted out to billionaire and Pershing Square hedge fund manager Bill Ackman, who made trades that reaped $2.6 billion (€2.4bn) of profits during March's coronavirus sell-off.

His bets, protested New York Post columnist Maureen Callahan, “may not technically, legally constitute market manipulation, but rational people can agree: It’s soulless and disgusting nonetheless.”

Ackman, in contrast, says his actions “were no different than a home owner buying flood insurance”.

Concerned in January by the potential impact of coronavirus, he says he considered selling his entire $8.5 billion portfolio of stocks, but instead took out cheap insurance in the form of credit default swaps to protect his positions. Pershing Square’s portfolio of stocks declined by roughly 30 per cent, but this was neutralised by his insurance policies increasing in value by the same amount.

Criticising Ackman is "idiotic", said AQR Capital Management founder Cliff Asness. "He bought protection early, as is his job if he has that view."

Hedge funds

One can criticise hedge funds for their hefty fees, but can one really criticise them for doing what they are supposed to do – that is, to hedge risk? Is it really "a sign of our broken economy that hedge fund managers are raking in billions, while care workers who are putting their lives on the line can barely scrape by", to quote Frances O'Grady, general secretary of the British Trades Union Congress? Short sellers and hedge fund managers aren't the only ones who have been criticised of late. "Rees-Mogg firm accused of cashing in on coronavirus crisis", headlined the Guardian last month, referring to criticism of a client letter by Somerset Capital Management (SCM), the investment firm co-owned by Conservative MP and Brexiteer Jacob Rees-Mogg.

SCM, which focuses on emerging markets, said in its letter that investors could make “super normal returns”, adding that “market dislocations of this magnitude happen rarely, perhaps once or twice in a generation, and have historically provided excellent entry points for investors”.

Commenting, Labour leader Keir Starmer said that "nobody should be seeking to take advantage of this crisis". The then shadow chancellor, John McDonnell, was more blunt in his criticism, saying: "This attitude is about as sick as it comes. Profit seeking from people's suffering is nearly as low as you can get."

In truth, the letter merely describes how emerging markets had become cheap and looked like a sound long-term investment – an uncontroversial sentiment shared by value investors around the world. It seems that, to some, it’s wrong to bet against stocks, it’s wrong to hedge stock risks by taking out insurance, and it’s wrong to purchase cheap stocks. Such moral outrage can be delicious, a way of advertising one’s moral superiority, but one has to ask – does it really make any sense?