Confessions of a Short Seller

Nice Interview with my pal Doug Kass, the "anti-Cramer" in this week’s Barron’s, called "
Confessions of a Short Seller

Doug runs a short only fund, Seabreeze Partners. He discusses a few key datapoints from the interview:

• As of April 30, flagship Seabreeze Partners Short fund was up 16.5% (vs 5.6% loss for the SPX)

• Since inception (January 2005) the fund is up 40.7%, versus a 15% gain for the S&P

• The amount of trading dollars that are in dedicated short pools are tiny:  About $5.4 billion (Knowledge@Wharton). That’s one-seventh the size of Fidelity’s Magellan Fund.

• The $5.4B dedicated short hedge funds are a sliver of the nearly $2 trillion of hedge-fund assets.

• Over the past two decades, 58% of the issues on the New York Stock Exchange have advanced, while 42% have declined — every year.

Here’s an excerpt from the Interview:

What makes short selling so difficult to do effectively over a long period?

The objectives of a long buyer and a short seller are similar. Both want to produce uncommon returns by taking common risk — typically by developing a variant view. Many believe short selling is a mug’s game, but I don’t, and thus far our results at Seabreeze have supported our opinion. But it is essential to maintain a disciplined short-selling strategy because, remember, risk and reward are asymmetric in selling stocks short. An investor can make only 100% if correct — that is, if the stock sold short goes to zero. But you can lose an infinite amount if you’re wrong as the stock keeps appreciating. And there is a gravitational pull of stocks higher over longer periods of time. So we use a very conservative approach to shorting.

Explain it, please.

First, we’re diversified across company and industry lines. No individual security exceeds 2.5% of our partnership’s assets and no industry sector exceeds 20% of the assets. We’ll have 35 to 40 holdings at any given time. Second, "Wee Willie" Keeler, a .341 lifetime hitter who played in the early part of the 20th century, liked to say he "tried to hit ’em where they ain’t." We try to do the same by being creative in our stock-selection process.

In what ways are you creative?

We strenuously avoid stocks whose short interest is high relative to the float, or companies whose shares have large short positions relative to their average daily trading volumes. Many short sellers have made the mistake of shorting valuation and have blown up during short squeezes. Avoiding them allows us to sleep at night and allows time for our negative fundamental catalysts to develop.

We also mitigate risk by avoiding leverage [borrowing to enhance the size of a position]. Historically, short sellers have taken concentrated positions, often in companies with small to medium capitalizations, and then used — and abused — leverage. That’s a recipe for disaster, particularly when they select investments with too many shorts. The average market capitalization of our holdings is more than $10 billion. Shorting large-caps is another way to control risk.

Interesting stuff . . .


Confessions of a Short Seller

Interview With Douglas A. Kass, President, Seabreeze Partners Management
Barron’s May 19, 2008

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  1. Timothy Sykes commented on May 17

    Hell yes great article! We short sellers are but a tiny tiny force but when you have so much greed and corruption in this joke of an industry, we’re ultimately profiting from all the junk that will always be around…always

  2. Patrick commented on May 17

    I’ve never understood the idea that short selling has unlimited risk while going long has max 100%. It seems to me that it has nothing to do with that and entirely a function of leverage. Ie you can be long and suffer an effectively unlimited loss just by being overleveraged. The diff between infinite and just broke is semantic.

    Ps b, I’m at the airport on my iPhone. Best phone ever. Get with the program you old fart ;p


    BR: All you can lose on the long side is however much money you put up. In theory if you use margin you could lose 200%.

    On the short side, short a stock at a penny and if it goes to $100 that’s a lot more than 100 or 200% loss.

    Theoretically, it is an infinite potential loss.

  3. Chief Tomahawk commented on May 17

    The Republicans have often called class warfare on some of the ideas tossed around by the Democratic party. But what is it called when speculation in the oil market is reaching into everyone’s pocket at the gas pump? Or, as transportation and production costs rise to cover fuel increases, higher food and clothing prices and eventually wage increases (and then the Fed cares?!? … if they actually targeted oil instead then I think they could nip the problem in the butt early.)

    I have a suspicion hedge funds are using the free market to maximize profit but it’s to the detriment of society on the whole now. Yes, I know that’s what hedge funds are supposed to do, and that they don’t get paid unless they make a profit. And no doubt they especially like obvious moneymaking trades, as oil is now. But their concentration of large amounts of assets for specific purposes (which includes speculation) is leading to a huge and sudden shift in wealth away from the poor, working and middle classes. And it’s going to take awhile before the upward cycle of price and wage increases stabilizes.

    Perhaps one day the spotlight will shine on hedge funds and how they can really put the screws to a bad situation (budget deficits and a real estate bust.) At what point does their behavior become unAmerican and/or inhumane?

  4. 2and20 commented on May 17

    Chief Tomahawk, please explain to us lesser traders what the obvious moneymaking trade in oil is right here right now?

    Or is it just another trade in hindsight you are pointing out, which is much easier? I have lots of great trades that I can point out in hindisight…

  5. SteveC commented on May 17

    Very sound principals by Doug. Making money on the short side is much more difficult than long. (If you don’t believe me, try it. You might be wearing a barrel before too long). Shorts serve a very important function in the market, uncovering fraud, and providing fuel for the next rally. Following short interest levels, both pro and retail, is something all aspiring traders should learn to do.

  6. John Borchers commented on May 17

    It is apparent to me that once a stock has a short interest over 5% it is very difficult for it to go down.

    Shorting in general is a losing game even if the stock goes down. Since the maximum gain is only 100% it would be far better to place the money on something you think will go up.

  7. Eric commented on May 17

    Barry, there’s something very fishy about the performance numbers cited by Barron’s for Doug Kass: (1) Kass has been in the short selling business for many, many years under the “Seabreeze Partners” name. In fact, Barrons itself has interviews with him going back years before January 2005. Why do they only talk about his performance for the past 2.5 years? That’s very suspicious. Even if this particular incarnation of “Seabreeze” only goes back to 1/2005, it’s a disservice to readers not to give a better idea of long-term performance. If Barrons did an interview with Landis in late 2006 and only quoted his performance for the prior 2.5 years, I suspect you’d have a big problem with that. (2) I am very familiar with Kass’ recommendations on RealMoney. And it’s pr etty hard to believe that someone who has made the calls that he has on that website is putting up those kind of numbers. Is he working with more than one investment vehicle? (See #1) (3) Kass regularly and plainly talks about how he is going long certain stocks (e.g. GS). So what does it mean then to be a “dedicated short seller”. Again, more than one investment vehicle? (4) I expect you are generally aware that Barron’s doesn’t like to bring up performance history with its interviewees unless it’s flattering. For example, last weekend they featured Bob Marcin, but they mentioned no performance figures at all — zero. And given how Marcin’s picks on RealMoney have done overall for the past 18 months or so, I can posit a good guess as to why.

  8. Jim commented on May 17

    The obvious way to avoid the “infinite loss” problem with shorting is to buy puts.

  9. rob commented on May 17

    You can certainly make money shorting crowded shorts you just have to anticipate that there will be fierce squeezes and manage your portfolio accordingly.

    Look at the short positions that have made the most money, a lot of them were crowded shorts.

    NEW, LEND and all the other busted subprimes were impossible to get a borrow on.

  10. Mark E Hoffer commented on May 17

    “The obvious way to avoid the “infinite loss” problem with shorting is to buy puts.”

    or, Conversely, buy the Call atop the Short..

  11. commented on May 17

    Short Warren Buffett?

    I have never really thought anyone should short Berkshire Hathaway (Warren Buffett’s company). Doug Kass is doing just that. In his blog, Mr. Kass goes through his reasoning (Doug Kass’ Blog). Doug Kass isn’t your average investor. I would say

  12. Speculator commented on May 17

    I think Doug Kass is one of the top 10 smartest people on Wall Street. Everything I have heard him say long or short is right on.

  13. heywally commented on May 18

    Interesting to read of the risk aversion that Doug utilizes in his short selling. That seems to be at odds with some of the ‘all-in’ short ‘calls’ (on the overall market) that he has made over at realmoney. There’s one from two years ago that he would still be down on (of course he doesn’t explain his risk management or update the trade status after his call) and he recently went all-in short (and as he updated several days ago – ‘and then some’) on the overall market – he’s down on that one now too. You’d think that he would scale-in the position to mitigate risk or wait for some more serious rolling over to kick in. The power of conviction.

    The risk (and I think it’s one worth being wary of if you’re ‘all-in’ short) he runs now is that we get some actual good news for a change – see what happens to the market then.

  14. Christopher Laudani commented on May 18

    Doug is an interesting guy. I didn’t know his dad was a dentist.

  15. Christopher Laudani commented on May 18


    Why is it so hard to believe Doug’s results?

    There’s no skullduggery here. The Barron’s writers aren’t dumb. They looked at his returns. Returns through April are probably not audited yet, but up to Dec 31st is audited.

    Doug only highlights a few picks on Real Money. He has lots of other positions that he doesn’t talk about. According to the article he has something like 40 positions and only writes about 3 or 4.

    When I contribute to RealMoney, I almost never write about my current ideas.

    As for the dedicated short part, why can’t he take long positions too? If its in the charter of his fund, he can take long positions. You need the flexibility in the fund to go long so you can manage risk. Sometimes when you are short, the stock goes up so you go long for awhile and then re-establish the short. Nothing wrong with that.

  16. Eric commented on May 18

    Chris, I don’t think you understood my questions/problems with the Kass piece. First, of course there’s nothing wrong with being long and short. That wasn’t my point. My point was wouldn’t that just make Seabreeze a typical hedge fund? I mean, Kass makes a big deal all the time about being in the uncrowded, $6 billion, “dedicated short” business. So I’m honestly wondering, what does that term mean? If the fund has both longs and shorts like 375 gazillion other funds, then what is a “dedicated short” fund? Second, if you reread my post you’ll see that my main concern was why Barrons only went back to 1/2005 for his performance, and just as importantly. And why do they talk about a 1/2005 inception when Barrons itself was interviewing Kass as manager of Seabreeze several years earlier than that? Again, if CNBC were to interview Kevin Landis in late 2006 and only tell viewers about his performance from 2003-2006, or talk about some new fund he was managing with a 1/2003 inception date, wouldn’t you raise an eyebrow? I bet you would. Third, if Barron’s was absolutely ***100%*** neutral on whether and to what extent they provide performance figures, then why do they sometimes not provide any at all? (e.g. Marcin in the prior week’s interview). Fourth, not that you or anyone here cares, but I personally think Kass is one of the least talented and most affected stock commentators I’ve ever seen. True, he doesn’t post all his moves on RealMoney. But for the Barron’s numbers to be accurate, he must be saving his worst stuff for TSCM.

  17. Eric commented on May 18

    By the way, I’m aware that Kass did great in pre and post tech bubble era — long in 1999 and then short in 2000. I’m not trying to suggest that there’s dark history to his fund. But I don’t get the 1/2005 inception date given Seabreeze Partners much longer track record.

  18. Eric Sebille commented on May 18

    Kass has been pumping his Ultrashort Oil and Gas play over on real money and is getting smoked on it. I like his logic it just seems he is always too early on his calls.

  19. Donald E. L. Johnson commented on May 19

    I’ve toyed with the idea of buying puts on stocks for years. And I’ve created puts watch lists, but I’ve never pulled the trigger because the puts market isn’t that liquid.

    If I were in the shorting biz, I’d be watching the energy sector for indications that the fundamentals and charts were changing.

    For example, there are indications that the buck is bottoming and interest rates are headed higher. What stocks will be hurt most for the long run?

    How about all of the companies that have been reporting inflated earnings as a result of the weak dollar? The big multinationals look vulnerable, and they may need a government bail out, don’t you think?

    Wonder how long Kass holds his average short position?

    How often is correct and how often wrong?

    Average gain and average loss?

    What are his trading rules, and how does he complement his fundamental analysis with his technical analysis, if he does?

  20. Chester White commented on May 19

    “First, we’re diversified across company and industry lines. No individual security exceeds 2.5% of our partnership’s assets and no industry sector exceeds 20% of the assets. We’ll have 35 to 40 holdings at any given time.”

    The math seems suspect, no?

    40 holdings at most means every one would be at 2.5%, the supposed limit. Any fewer holdings would mean that at least one is above 2.5%.

    Unless he’s holding cash and not counting it.


    BR: Cash, options, bonds explains the difference

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