By: Siyanda Pali
First published: 14 December 2017
“I met my wife on Match.com with a profile which stated that I am a Medical student with one eye, have awkward social mannerisms and $145 000 US in student loans. She responded, “I like that.” She meant ‘honest’. So, let me be honest”.
Dr. Michael Burry was a Medical Doctor turned Hedge Fund manager on Wall Street. However, there was nothing about Burry that resembled Wall Street. He was, in fact, contrarian in every sense of the word. He resembled a surfer beach-bound in his office, clad with shorts, a t-shirt and flip flops to match. He walked around his office bare-foot. Michael was one of a few mavericks to pull off one of the biggest coups in Financial Markets history in 2007/2008. It’s his last letter to his shareholders of Scion Capital quoted above, referenced in the 2010 biopic, The Big Short, which is difficult to forget.
Dr. Michael Burry’s and a few other misfits (protagonists and antagonists) relevance in this equation will soon be revealed.
The last few weeks have been tumultuous in South African financial markets. This is amid revelations of the brazen capture of state institutions by certain forces. Newly appointed Finance Minister Malusi Gigaba also had the unpleasant task of explaining how he plans to cover a R50 billion shortfall in his Medium Term Budget Policy Statement. In response to the former-mentioned, Equities Trader and Hedge Fund Manager James Gubb embarked on what he terms as protest action, manipulating the intraday trading price of Oakbay shares on 31 March 2017 in order to give the Gupta family the proverbial middle finger, figuratively.
His statement provides the rationale for the abovementioned. “Firstly, as a form of protest at the state capture by the Gupta family of various state-owned enterprises and organs of the state in South Africa. Oakbay is controlled by the Gupta family. During the last week of March, tens of thousands of South Africans protested in various ways against corruption and state capture by the Gupta family, a lack of accountability within government...I traded in Oakbay on 31 March with the view of creating an intraday image that would aptly convey my contempt and outrage at the actions of such people and bring attention to the relationship between the Gupta family and Oakbay...Secondly, as an initial artistic exploration of the financial media as a platform for Protest Art, in the form of the creation of a recognisable object or figure in the price chart of a publicly traded security that has political and/or humorous significance.”
Just as James Gubb was about to achieve a perfectly symmetrical figure, with accompanying mathematical elegance in the sense that the price would return to exactly where it was prior to making the trades, ie no profit being made, the JSE stopped him in his tracks.
Some may see the humour in Gubb’s act, whilst others may applaud him for standing up against injustice. However, the Financial Services Board did not hesitate to give him a R100 000 fine, despite the trades being worth approximately R400. The Directorate of Market Abuse referred the matter to the Enforcement Committee which, after investigation, revealed that Section 80(1) a of the FMA was contravened. In essence, Gubb’s trades were seen to have created an artificial price for the security traded and ultimately, undermined the integrity of South Africa’s financial markets.
Gubb’s trades were insignificant financially, to say the least. However, it is common knowledge that market manipulation and corruption of far grander scales takes place in financial markets, both in South Africa and the world over.
Steinhoff International Holdings NV has come under immense pressure and scrutiny as German prosecutors launched a criminal investigation into the retailer for possible accounting fraud. The refusal of Auditor Deloitte to ratify Steinhoff’s financial results and subsequent resignation of Steinhoff’s CEO, Markus Jooste, sent the share price tumbling on the JSE from R46 to approximately R6 by the end of the trading day last week Friday. A colossal R194 billion was eroded from the South African equity market. This is also particularly vexing because not only the Public Investment Corporation, which invests on behalf of the Government Employees Pension Fund, pension funds for approximately 230 000 civil servants, but also funds from other asset managers, have been jeopardised.
Earlier this year in South Africa, it emerged that up to 19 financial institutions colluded in rigging the currency market between 2007 and 2017. The above occurrence begs the question: should short-selling be banned in South Africa?
Going short, which comprises of borrowing, selling securities which one does not necessarily own and buying back later at a lower price, has been suspected as a major contributory factor in market manipulation and the rapid liquidation of securities in economies. The standard approach, as is common knowledge, is to own shares for their appreciation in value, a huge difference when measured for impact on a nation’s economy.
However, before dealing with the issue at hand directly, it is prudent to delve a little deeper. In the 18th century, French Mathematician Pierre Simon- La Place pioneered and popularized Bayesian Probability theory, which, according to RT Cox (1946), follows that Bayesian probability is an interpretation of probability theory. In essence, it is at the centre of many a strategy for fund managers today.
There are notable bulls who have embraced a Long only strategy, with rather impressive returns over time. Value investor Warren Buffett has achieved remarkable returns at the helm of Berkshire Hathaway, amassing an impressive 20.8% compounded annual percentage change in per share market change between 1965 and 2016 when he opened the partnership to a few investors for an individual contribution of $10 000 US each. It goes without saying that his savvy and sound investment philosophy has created several millionaires, a deceptively simple strategy which benefits society at large.
Not so a controversy-embroiled short, or a big short in the case of George Soros in 1992 when he expressed his sentiments about the ability of the British Pound to remain pegged to the German Bundesbank’s Deutschmark, without certain negative externalities for the English economy. Soros was correct. The British pound was over-valued upon joining the ERM. It was only a matter of time before interest rates sky-rocketed in England and the British economy experienced shockwaves. It was also a big short when Dr. Michael Burry, a medical doctor turned investor and hedge fund manager as well as others such as Steve Eisman, Mark Baum and John Paulson, executive chairman and fund manager at Paulson and Co. LLP, shorted the housing market in 2006/7 by buying Credit Default Swaps on mortgages in their respective tranches. Cornwall Capital, headed by James Mai, Charlie Ledley and Ben Hockett had the insight to also short the AA tranches, earning themselves a handsome reward.
What is now regarded as The Greatest Trade Ever, the title of Gregory Zuckerman’s memoir of the 2007/2008 trade, provides some colourful insights about the few who saw and acted upon what many didn’t. Wall Street hedge fund manager of Paulson and Co. LLP, John Paulson made the trade which has now taken its rightful place in the annals of history. Those like Paulson who made the trade express what the immense challenges of making such a trade were, such as maintaining fortitude despite noise from investors, the media and lagging responses from the rating agencies, who were responsible for accurately representing the quality of the above assets in the market. For his trouble, Paulson made a staggering $ 20 billion US on the trade, completely dwarfing Soros’ $ 1 billion US made in 1992.
The above tales paint a somewhat rosy picture of short-selling (for the traders and fund managers). However, there is little made about the adverse effects that shorting can have on a nation’s economy. As stated above, the currency manipulation which took place in South Africa over an entire decade would not be possible without short selling. Investigations into the culprits responsible for the market rigging reveal that their communication included ideas about when to buy and sell, resulting in periodic, synthetic market moves orchestrated by the cabal. A country’s currency is perhaps one of its greatest symbols of national pride and sovereignty. Manipulating this raises strong moral questions because it not only affects citizens lives directly, ie less purchasing power and an invariable loss of opportunity, but it also inaccurately portrays the viability of a nation in the face of foreign investors. There has been even less emphasis on how one of the greatest headlines in South African financial history has resembled a mere footnote as played out in the media and civil society. First, it was African Bank, which, on 10 August 2014, was placed under curatorship in terms of the South African Banks Act, Act 94 of 1990, by the South African Reserve Bank. Today, we have Steinhoff International Holdings NV, which has had its share value evaporate over a matter of days amidst a corruption scandal. Close to R194 billion of value has disappeared.
On the surface, it seems as if the short-seller embarks upon the destruction of value, purely for selfish gain. There are nations which do not allow short-selling eg France. Some see this as a morally questionable strategy, given its possible impact. However, if nothing untoward has taken place in terms of the contravention of market regulation, shorting, especially when dealing with large institutional investors, does possess some benefits. Fundamentally, short-selling allows one to express an opinion, regardless of whether this is a pleasant opinion to the bond/shareholder or not. A ban on this is testament to stifling this expression, a nullification of the basic principles of Probability theory in financial markets. Furthermore, companies and various markets, at times, possess inherent inefficiencies or inaccuracy as portrayed by prices. Prime examples of the above are the US housing market in 2008 and recently, Steinhoff International Holdings NV in South Africa. Therefore, a short position allows market participants to access information which may or may not be represented on company balance sheets, ultimately leading to better price discovery and better efficiency of markets.
The Johannesburg Stock Exchange, one of the most well-regulated stock exchanges the world over, abstained from suspending trading in Steinhoff shares, given its primary listing in Germany. Furthermore, one of the primary functions of a stock exchange is to provide liquidity. Therefore, engaging in the abovementioned would have somewhat defeated the performance of this function.
Whether one takes a long or short position in Steinhoff shares in the interim, amidst the investigation by the German prosecutors is soley the discretion of the individual. However, what should be unquestionable, is the integrity of South African financial markets. The geist at this moment, is for the South African Institute of Directors, the Financial Services Board, the JSE, the IIASA, the SA Ministry of Finance as well as all other relevant parties to ensure that corporate governance in South Africa stands the test of time.
