30 SECOND GUIDE TO ...

SHORTING

As in a fuse? NOPe. We’re taking financial, not electrical. Most investment funds only bet on shares in a company going up in value. But hedge funds can also gamble on a firm’s stock price falling. This is known in the trade as ‘shorting’.

How does it work? Typically by borrowing a stock from another institutional investor, such as a pension fund, for a small fee. As part of the deal they promise to hand the same number of shares back in the future. They then sell the shares in the hope the share price falls. If all goes to plan they buy the shares back at a cheaper price, return them to the investor and pocket the difference.

Give me an example A hedge fund could borrow a share worth £10 and promise to return the share in due course. It then sells the share for £10. The hedge fund waits for the price to fall to £5 when it buys the share back. It then returns the share to the investor it borrowed it from and pockets the £5 difference as a profit, minus any fees. Alternatively the share price could rise, leaving them out of pocket.

Sounds complicated And controversial. hedge funds were criticised for selling shares in high Street banks ahead of the financial crisis, driving them to the wall and leaving the taxpayer to pick up the bill. If hedge funds short a large number of shares in a firm this can cause other investors to panic and sell their stock, driving down the share price.