On Septemeber 22 I pointed out that the new short selling rules would create mega problems for the hottest new product from the mutual fund industry : 130/30 and other long short funds.
Wall Street Journal
SEPTEMBER 24, 2008
Short-Sale Ban Is Hitting Mutual Funds
Some Managers Say They Aim to Avoid Big Cash Amounts
A new ban on short sales of financial stocks is hitting many mutual funds and exchange-traded funds that make bets against these shares.
Mutual funds that bill themselves as "market neutral," "long-short" or "bear" funds often short stocks, which typically means they sell borrowed shares in the hope of buying them back later at a lower price. The Securities and Exchange Commission late last week issued a temporary ban on new financial-stock short sales in a bid to maintain orderly markets.
Many fund managers are still assessing how they will be affected by the ban, which is in effect through Oct. 2. Some say they will avoid accepting large amounts of new cash from investors or adding to conventional financial-stock "long" positions during the term of the ban. Among the funds most affected are ETFs that don't even short stocks themselves but use swaps and other complex financial instruments to make bets against financials.
Fund companies in recent years have rushed to roll out new funds that mimic hedge funds' strategies, including short selling. Investment research firm Morningstar Inc. now tracks 64 long-short funds, which typically blend short positions with traditional outright stock purchases, and 41 bear-market funds, which are designed to perform well when stocks fall.
The SEC's ban has become even more complex for funds in recent days as the original no-short-sale list of nearly 800 companies has expanded rapidly. Among the stocks that joined the list Monday are Ford Motor Co., General Motors Corp. and General Electric Co. "Trying to keep up with that list is a pretty challenging feat," says Barry James, co-manager of James Market Neutral Fund. "We don't like having more and more [stocks] taken away from us."
Some managers with significant financial short positions say they will avoid taking in much new cash for now. Ric Dillon, chief executive and chief investment officer of Diamond Hill Investment Group, says he would have to turn away any substantial new investment in his Diamond Hill Financial Long-Short Fund during the term of the ban, since he would be able to put that money to work only on the long side. Mr. Dillon calls the SEC's action "misguided" and says his own publicly traded company asked to be removed from the no-short-sale list. "What you've done by eliminating the short sellers is eliminated information content," Mr. Dillon says. "That's bad for markets."
This leaves the investors in what is now a long only financial services fund with an annual management fee of 2,56%, The long only Vanguard financial services exchange traded fund has a management fee of .25%.
More broadly diversified fund managers say they will continue taking in new money but will avoid the financial sector for now because they don't want to upset their balance of longs and shorts. Kurt Borgwardt, manager of the American Century Long-Short Market Neutral Fund, says he would put any significant new cash to work in nonfinancial sectors because he likes to keep his long and short positions within each sector roughly equal……
Many fund managers are concerned the short-sale ban could be broadened to include even more stocks or extended to a longer period. "Hopefully it's not the beginning of something larger," says John Boich, portfolio manager at Security Global Investors. "If it is, then you're talking about a wholesale change in how alternative strategies are managed
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