This $1.6 Trillion Fund Says Short Selling Is Wrong

(Bloomberg Opinion) -- Japan’s Government Pension Investment Fund has been a trailblazer in promoting the need to incorporate environmental, social and governance issues into the day-to-day job of portfolio construction. With $1.6 trillion under management, it has a lot of firepower in the investing world. So its recent stand against short selling, judging the practice to be incompatible with its role as the long-term custodian of multigenerational assets, is worth paying attention to. 

In a short sale, a trader borrows stock from a broker or bank and sells it at the prevailing market price, betting that a decline will allow him or her to return the shares to the lender after repurchasing them at the new, lower value and pocketing the difference. For the trade to work, some owner of the shares has to be willing to lend them to the short seller.

Last month, GPIF announced that it will stop lending out its foreign shareholdings, which were worth about 42 trillion yen ($381.6 billion) when last reported in March. (It doesn’t lend Japanese shares.) Chief Investment Officer Hiro Mizuno told the Financial Times that the practice of short selling isn’t consistent with what his organization,  the world’s biggest pension fund, expects from both its portfolio companies and its asset managers. “I never met a short seller who has a long-term perspective,” he said.

Mizuno takes his mission of promoting the long view seriously. Two years ago, he realized that reviewing the performance of the fund’s external managers every year conflicted with the long-term goals he espoused. So he started offering five-year contracts to firms wanting to manage money on behalf of GPIF, linking their fees directly to performance. The decision to stop lending the fund’s foreign shares carries a financial cost. It has been making about $100 million per year of revenue from lending out its stock, Mizuno said last week.

From his perspective, one of the problems with lending out shares is that it reduces an investor’s ability to engage with company boards about their ESG record, especially if the shares are out of the owner’s possession when stockholders get to vote on company policies. Failing to hang on to ownership of a company’s stock also inhibits asset managers’ ability — and in Mizuno’s view duty — to have “continuous and constructive” discussions with management in order to take informed decisions when voting. 

The Japanese fund’s stance against short selling is at odds with the orthodox claim that the ability to speculate on a decline in stocks contributes to a more liquid two-way market and helps generate price transparency — an argument that Mizuno acknowledges, but sees as conflicting with his long-term perspective.

It’s also at odds with many of GPIF’s peers. Norway’s sovereign wealth fund, the world’s biggest with more than $1 trillion of assets, views its securities lending as “contributing to well-functioning markets,” according to Marthe Skaar, a spokeswoman for Norges Bank Investment Management, which manages the fund from Oslo. In its most recent financial year, the fund made a net income of about $387 million from its lending program. While that’s a negligible amount of money for the Norwegian behemoth — the fund made more than $28 billion in its most recently reported financial quarter — stock lending provides a valuable source of income for many passive funds, some of which are free to customers as a result of the subsidy available.

So it’s little wonder that Mizuno told the FT that his move has had a mixed reception, although he did say that “we already heard from several asset owners that they think they should discuss this as well.”

I’m sympathetic to the GPIF chief’s ongoing efforts to use his fund’s financial clout to move the needle on how the world’s capital markets impact the way companies do their business. But I’m less convinced the alleged evils of short selling’s short-term approach outweigh the positive contribution that being able to bet against a company’s share price makes to efficient price discovery.  Indeed, in a paper published last year by the Boston University Law Review, law professors Peter Molk and Frank Portnoy argued that institutional investors such as pension providers and sovereign wealth funds should actively participate in short selling “to improve the efficiency and fairness of equity markets.”

Nevertheless, Mizuno is convinced his approach to short selling is in tune with an investment philosophy that tries to foster a more moral and less short-term financial environment. “We used to think the whole responsibility of the asset manager is to make money,” he told a seminar at Oxford University last week. Now, “we’re more proud of our long-termism.” If other big institutions follow suit, short sellers could find themselves struggling to borrow shares in future.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Mark Gilbert is a Bloomberg Opinion columnist covering asset management. He previously was the London bureau chief for Bloomberg News. He is also the author of "Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable."

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