Small investors lose when short sellers manipulate market

Although the ASX apparently welcomes short selling because it facilitates trading volumes and contributes to its profitability, the open-ended arrangements allowing hedge funds and traders to engage in short-selling borrowed shares can and does lead to price manipulation. 

Short selling is legal under current rules provided the seller borrows shares from an existing owner and reports the transactions to the ASX. Reporting details of short-sale transactions is of little benefit to small investors who, with rare exceptions, do not consider the possibility of short selling in making their investment decisions. 

The best protection against short sales is provided by owning companies confined largely to those in the ASX 50 or ASX 100 indices. The large market capitalisation of those shares means that only large short selling will depress market prices. 

Even then, with billions of dollars at their disposal, hedge funds and other large traders can ensure falling share prices even in some of our larger companies are a self fulfilling proposition. The profits on offer are high in the case of companies releasing profit downgrades and disappointing exploration or product-testing results. 

Prime targets for short selling include companies likely to fall out of a key index such as the ASX 100, 200 or 300. Movement out of one of these indices forces the relevant index funds to dispose of their holdings in that company, usually quickly. 

With substantial assets at their control and acting as a pack, the hedge funds can even ensure that companies are removed from the >relevant share index. Picking the targets is not a complicated exercise given there is full disclosure of how the ranking in the share indices is calculated. 

There used to be some limits on the extent of short selling posed by the difficulty of borrowing shares to be sold on the market.But forsome inexplicable reason, almost all of our large institutional investors, including our superannuation funds, are prepared to lend their shares to short sellers relatively cheaply. 

This is despite the fact the beneficial owners of these shares, including managed fund and public offer super fund investors, lose out if the shares they own fall in value. It would be far better if they sold the shares rather than lent them with the profit then going to thebeneficial owners instead of the short sellers. 

While the ASX might consider that short selling improves the liquidity of the sharemarket, the reality is that it opens up unfair opportunities for the hedge funds and traders to profit at the expense of smaller investors, especially those investing in smaller companies.

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Daryl Dixon

Executive Chairman

Daryl Dixon is one of Australia’s foremost investment experts and a well known writer and consultant. He has provided trusted advice to thousands of personal clients over more than 25 years and is an acknowledged expert in the areas of tax, superannuation (including public sector superannuation), social security and investments.

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