A senior fund manager at Prudential has branded hedge funds selfish, and labeled derivatives as the scourge of the modern age.
Tom Dobell, fund manager of the GBP3 billion Recovery Fund for M&G, the asset management unit for Prudential, made the remarks in his latest letter to investors.
According to the letter, Dobell states: we have continued to be straightforward, plain-speaking bottom-up stockpickers. Common sense and patience remain more compelling than any computer model or black box. We have strenuously avoided the use of derivatives, which I regard as the scourge of the modern age, and have often been at loggerheads with the hedge funds, many of whom I regard as clever, but selfish and short-term. We have refused to fuel their often secretive and devious tactics by lending out stock in the companies that we hold [in] the fund and, in contrast to many, have tried to be open and transparent in everything we do
The remarks, coming at the end of what is a comparatively standard letter to investors, has sparked debate across the blogosphere. John Whipple, Pension Fund Trustees, commenting on the CityWire website, questions the Pension Fund trustees role in “lending” stock to hedge funds to enable shorting. Is it not the legal duty of these trustees to act in the long term interests of the pension fund membership rather than make a few quick bucks?
The debate on the sanctity of short selling has continued since the collapse of Lehman Brothers in 2008. But a closer look at the at the major holdings of the Recovery Fund show positions in some of the largest and most liquid stocks: BP, HSBC, Royal Dutch Shell, Glaxosmithkline, Vodafone and Unilever amongst the top ten holdings. These shares are liquid enough for the Recovery Funds participation in short selling to be immaterial.
Roy Zimmerhansl, Zimmerhansl Consulting Services explains that Securities lending is a recognised and legitimate business activity supported by regulators, trade organisations and thousands of active market participants around the world. Risk-reward decisions are appropriate at the individual firm level and require knowledge, understanding and data as with any investment decision.
A substantial body of academic work exists that has examined the effect of short selling on the stock markets. These studies consistently point to improved price discovery, enhanced market liquidity and that institutions are more confident investing in markets where all views (positive or negative) are able to be acted upon. In such an efficient market, any unfounded or incorrect negative views on a company would result in buying opportunities for investors.
At the practical level, securities are borrowed for a variety of purposes ranging from straightforward greasing the wheels of operational processes through to most controversial end of the spectrum with directional short selling. Sandwiched between these extremes lies the bulk of borrowing demand which is for the purposes of hedging or arbitrage transactions. Directional short selling is the least common driver for borrowing shares and bears the highest risk profile with potentially limitless losses and a fixed upside. Indeed, benchmarking data shows short-biased hedge funds have posted more negative performance years than positive years.
Dobells views are not universal within Prudential. According to one industry source, the insurance giant has a history of short selling. They are extremely thoughtful and intelligent with their approach to the business and have generated significant sums for their investors and policy holders over the years. Nevertheless, I believe that it is their policy that participation is not mandatory for the funds within their group to participate and that the discretion remains with the fund manager, he said.
Giles TurnerNews Editor