While the average hedge fund is up 8 percent so far this year, portfolios that bet on falling prices are down 5.5 percent, according to Hedge Fund Research Inc., BusinessWeek reports.
The strategy is suffering more from the number of short-sellers playing the game.
“We’re hearing it’s harder and harder to make money on the short side,” says Robert Discolo, head of hedge fund strategies at AIG Global Investment Group (AIG).
Yet, In June, short interest on the NYSE Euronext hit an all-time high of 3.3 percent, or 12.4 billion shares, double that of 2000.
Much of the recent growth is coming from new products such as the 130-30 fund, a cheaper alternative to traditional hedge funds being developed by banks, mutual fund companies, and other asset managers.
The increased competition, in turn, is driving up costs. In a typical short transaction, hedge funds or other investors put up cash as collateral to borrow the stock they want to short from a bank or broker. In return, those securities dealers pay them interest on the cash which helps generate income for the funds.
But if there are too many shorts swarming a company, investors must pay to borrow the stock. Hard-to-borrow stocks can cost 2 percent to 40 percent a year, meaning the price has to fall by at least that amount before the short-sellers can make any money.
“As more 130-30 and hedge funds raise money, I think demand for borrowed stock could easily outstrip supply, and the costs will go up,” says Josh Galper, managing principal of researcher and consultant Vodia Group.