PI Global Investments
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When It Comes to Achieving ESG Goals, Is Short Selling More Effective Than Shareholder Activism?

Shareholder activism and divestment have been the favorite strategies of investors interested in achieving environmental, social, and governance goals. But taking short positions on companies that don’t follow ESG rules might help, too. 

James Jampel, founder of the $700 million hedge fund HITE Asset Management, believes that shorting can play a powerful role in helping the economy reduce carbon emissions. It may even work better than shareholder engagement, because it allows investors to avoid the conflict of interest that arises from holding long positions in ESG laggard companies, he said.

According to Jampel, the problem with shareholder activism is that investors with long positions are often bound by fiduciary duties to make money from rising stock prices. As a result, they are less likely to support ESG policies that would lower company valuations. But shorting solves the problem. For example, if investors take long positions in both ExxonMobil and Chevron, they aren’t likely to welcome a carbon tax policy — at least not one that would hurt both companies. But if they short one of the two, they would become indifferent to the policy and can act as neutral investors. 

“You really cannot, without a conflict of interest, advocate for significant government intervention in carbon markets [with a long-only portfolio],” Jampel said. “There’s this inherent conflict within the investors [who] care about ESG, because they want to be able to change the company by owning it. But if you own it, you don’t want to decrease its profits, even if that is what might be necessary to decrease emissions.”

There has been a surge of research interest in measuring short selling’s impact on ESG goals. A white paper by Harvard Management Company and the Managed Funds Association recently found that short positions can reduce capital investment in the most polluting companies by 3 to 8 percent. In addition, short selling can put downward pressure on equity prices and increase the cost of capital, according to the white paper. The findings have earned HMC a nomination for the fifth annual Allocators’ Choice Awards. 

Yet not all investors agree that shorting should be counted as ESG. In an MSCI study published in April, the researchers found “limited evidence to support the view that shorting raised the cost of capital on a consistent basis.” They added that short positions don’t give shareholders any direct control over the company, which means they can’t be treated the same as long positions. While MSCI didn’t eliminate the possibility that shorting may help improve the ESG performance of companies in individual cases, it recommends that investors report long and short positions separately for maximum transparency. 

Jampel cautions that taking short selling out of the ESG equation will have an adverse effect on hedge funds with long-short strategies. “Without allowing shorting to count [as ESG], you are discouraging energy market neutral funds from getting capital,” he said. “And these types of funds have the greatest chance of affecting change with the least amount of risk for the investor.”

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