In the most simplistic terms, the most common type of hedge fund is the long/short equity fund, where the manager can monetize his view on both underpriced securities (by going long) and overpriced securities (by going short). While the addition of shorting equities in a portfolio generally has the added benefit of offsetting some of the market risk in the portfolio, the short exposure will also reduce the contribution to the portfolio from the market’s return (reducing the “Beta” of the fund). For that reason, combined with generally rising markets, the vast majority of long/short funds are long-biased, where the portfolio is tilted toward a larger long book that is positively correlated to the equity market. However, there is a very small subset of the long/short equity universe where the reverse is true. These short-biased (or even short-only) equity managers focus their research efforts primarily on identifying opportunities on the short side. What long exposure they have, if any, is often to reduce the pain of a market rally while they wait for their shorts to play out. However, the negative correlation of being net short creates a large headwind for short managers in rising markets, causing many talented short managers to go out of business during extended bull markets. Over the last decade, our team has conducted research on fundamental short equity managers to get a better understanding of what makes a good short opportunity and what the potential pitfalls are. Regardless of whether we utilize a dedicated short seller in our funds or not, the insight from this research is extremely valuable when assessing traditional long/short equity managers. Pitfalls common on the short side of traditional long/short managers include sizing shorts too large, investing in shorts with high short interest (which increases the chances of getting “short-squeezed”), excessive borrowing costs that are not being accounted for when constructing the portfolio, and not fully appreciating the asymmetric risk profile of being short. Short books also require dynamic rebalancing as exposures organically grow or shrink in a different way than long books do. Opportunities on the short side, much like the long side, can be very diverse; Industries in meaningful flux can generate as many short opportunities as long opportunities, as can differences in a manager’s growth or earnings assumptions compared to the market consensus. The short side, however, has the extra benefit of being able to seek out and monetize “accounting shenanigans”, sometimes where there is outright fraud. These opportunities, which are often ignored by traditional long/short managers, not only have the ability to generate attractive returns, but also investor infamy for a short seller. For example, Jim Chanos of Kynikos is the most famous dedicated short seller, partly due to being the first hedge fund manager to uncover the fraud at Enron. Many short managers have since tried to make a name for themselves by publicly sharing their research on fraudulent practices they have uncovered. More recently, short seller Andrew Left has achieved notoriety for accusing Valeant Pharmaceuticals of accounting fraud. Notably, he even compared the company to Enron. This widespread release of research is a more recent development in the short-only space and can also serve as the catalyst for the stock to drop. As a result of the above-mentioned headwinds for a short-biased portfolio, more and more dedicated short sellers like Andrew Left are moving toward a business model where they sell their research to other funds. But some short sellers are also beginning to raise capital for funds dedicated to specific short ideas. We have invested in at least one such fund already and are always evaluating the benefits of adding a short specialist into our portfolios.