The ban on short-selling financial stocks is wreaking havoc on the carefully calculated strategies of quantitative fund managers — and could actually drive down the beleaguered bank stocks it was intended to prop up, say some experts. “Rules that are driven more by fear than by any rational calculus always have unintended consequences,” notes Andrew Lo, a leading academic and the chief scientific officer of AlphaSimplex Group, a $600 million quant shop owned by Natixis Global Asset Management. “There will be some dislocation because you may not have time to rewrite your algorithms — you may just get out of the financial sector altogether.”
The Securities and Exchange Commission’s September 19 ban on short-selling a list of financial services stocks was extended to October 17. Similar restrictions are in place in the U.K. and other countries. The ban kicked in as U.S. lawmakers were scrambling to pull together a $700 billion government bailout of financial companies that have teetered on the brink of collapse. Short-sellers have taken heat for making bets that these firms’ share prices will tank, pushing prices down further.
Excluding pure-play hedge fund managers, there are about 100 institutional money managers — including Barclays Global Investors and State Street Global Advisors — in the U.S. that use complicated mathematical models instead of human analysts to pick stocks. Together they manage more than $2 trillion, including $100 billion in long-short strategies that hedge bets by shorting stocks while holding long positions at the same time, such as portable-alpha and 130/30 strategies.
However, there’s no reason to own a stock on the long side if it can’t be shorted, so some quant managers are bailing out of financials altogether, driving down the share prices of financial services firms even further. There could be a replay of what happened in August 2007, when a couple of quant funds that sold stocks exposed to subprime mortgages triggered massive sales by automated trading programs, according to research conducted by Lo, a professor of finance at the Massachusetts Institute of Technology Sloan School of Management. Given the rapid collapse of confidence in the U.S. financial system, the stakes today are much higher.
