Kynikos Associates’ Jim Chanos on July, 15 2004 on a panel discussion with the SEC discusses the hedge fund strategies and market participation. Also see: Jim Chanos Testimony On Hedge Fund Regulation
President, Kynikos Associates
U.S. SECURITIES AND EXCHANGE COMMISSION
ROUNDTABLE ON HEDGE FUNDS
Panel Discussion: “Hedge Fund Strategies and Market Participation”
Thursday, May 15, 2003
My name is Jim Chanos and I am the President of Kynikos Associates, a New York private investment management company that I founded in 1985.1 I am honored to have the opportunity to participate in today’s panel entitled: “Hedge Fund Strategies and Market Participation.” I would like to commend the Commission for undertaking such a thorough review of all the possible issues surrounding hedge funds as a prelude to making its recommendations for any changes to the regulatory structure.
Kynikos Associates specializes in short selling, an investment technique that profits in finding fundamentally overvalued securities that are poised to fall in price. Kynikos Associates employs seven investment professionals and is considered the largest organization of its type in the world, managing over $1 billion for our clients.
On behalf of our clients, Kynikos Associates manages a portfolio of securities we consider to be overvalued. The portfolio is designed to profit if the securities it has sold short fall in value. Kynikos Associates selects portfolio securities by conducting a rigorous financial analysis and focusing on securities issued by companies that appear to have (1) materially overstated earnings; (2) an unsustainable or operationally flawed business plan; and/or (3) engaged in outright fraud. In choosing securities for its portfolios, Kynikos Associates also relies on the many years of experience that our team has accumulated in the equity markets.
Kynikos has sometimes been called a “hedge fund,” but it is not a hedge fund following the classic model first established by A.W.Jones & Co. We operate a short fund. With the proliferation of private investment funds, however, the term “hedge fund” is now used so broadly in some quarters to refer to any private investment fund that I do not believe that it accurately describes Kynikos’ business model accurately.
In almost any market environment, professional short-sellers are a small percentage of those actively engaged in the markets. The bull market of the 1990s drove a number of previously short funds into alternative strategies or out of the market altogether. In today’s less robust market environment, however, a number of new participants have emerged and, with them, heightened public, corporate and regulatory scrutiny of the practice of short selling has ensued, as it does during almost every prolonged market downturn.
Following a brief discussion of the general benefits of short selling, I wish to address, in the strongest manner, my belief, which is borne out by testimony, experience and empirical analysis, that short selling is beneficial to the markets not only in the technical aspects of providing liquidity or a hedge against long positions, but also as an important bulwark against hyperbole, irrational exuberance, and corporate fraud. As Bernard Baruch said nearly ninety years ago: “To enjoy the advantages of a free market, one must have both buyers and sellers, both bulls and bears. A market without bears would be like a nation without a free press. There would be no one to criticize and restrain the false optimism that always leads to disaster.”
Who Sells Short?
There are three main categories of market participants who sell short, and they do so for differing reasons. The first category is exchange specialists, market makers and block traders who will sell short for technical reasons in order to maintain customer liquidity and price stability.
The second category of short sellers are those who are engaging in market neutral arbitrage and are seeking to take advantage of temporary or minute price discrepancies in markets or in similar securities.
See full Jim Chanos Testimony on Hedge Fund Strategies in PDF format here.