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To begin with the former, by taking both long (buying and Responsible investment by religious investors who may, for instance, not wish to The interaction between short selling and socially respon-
holding) and short positions, hedge fund managers can see their capital allocated to a company producing arms sible investment, meanwhile, will depend on the goals
limit their exposure to market risk. In so doing they can Responsible investment is a very broad term, but it can and munitions. underlying the latter. Some investors may wish to screen
ensure that the major risks in their portfolios are idiosyn- best be understood through a teleological lens. Broadly certain assets from their portfolios in order to increase
cratic—risks unique to the individual assets in which they speaking, all forms of responsible investment aim to Short selling and responsible investment the cost of capital for those assets. In such case, it would
invest. This limiting of market exposure allows hedge fund generate alpha, manage investment risk, create posi- make sense for a hedge fund firm to short those screened
managers to protect and grow the capital of their inves- tive impacts, or express an ethical or religious belief From the descriptions above it should be clear how short assets. Some investors, however, may take the view that
tors no matter which way the broader markets are moving. (or all four). A manager’s or investor’s primary goal will selling and responsible investment align. Short selling deriving any profit from proscribed assets is unaccept-
determine which form of responsible investment they can be used as part of a responsible investment strategy able, even if that profit is derived from shorting. This is a
Some managers also use short selling in a more active will implement. to mitigate risk, and also as part of a strategy to create maximalist position, and tends to be relatively rare, but
way. These managers adopt an investment strategy of social and environmental goods. Some managers also managers would be well advised to consult with their
identifying assets that are overvalued, taking short posi- It should come as no surprise to anyone familiar with short assets they have screened from their portfolios, investors before shorting screened assets.
tions on them, and waiting for the market to correct. For the hedge fund industry that the most common goal of further increasing the cost of capital for the issuers of
instance, a hedge fund manager may conclude that a responsible investment amongst hedge fund managers those assets. Short selling is not about speculation, and responsible
widget manufacturer’s profit expectations are overopti- is risk management. Many managers see the analysis investment is not about avoiding financial innovation.
mistic, and as such so is the price of its equity. The man- of environmental, social, and governance (ESG) factors To begin with risk, short selling can be used to hedge Combining short selling and responsible investment is a
ager could short that company’s equity and profit if their in the investment process as a way of mitigating risk. out more than just market risk. It can be used to nar- powerful way to limit systemic risk and drive social and
conclusion turns out to be correct. ESG integration, as this process is generally known, is row a portfolio’s exposure to any kind of systemic risk. environmental objectives. Short selling and responsible
rapidly gaining in popularity in the hedge fund indus- Environmental and social factors are often systemic (gov- investment are not only compatible—they strengthen
Short selling is not a tool for idle speculation. Many try. For instance, by examining the environmental ernance factors tend to be idiosyncratic). each other.
criticisms of short selling seem to be premised on the factors to which a company is exposed a hedge fund
belief that it is a technique used to profit from the pain manager may be able to avoid the risk of that compa- They affect a variety of assets in different ways. This opens AIMA will continue to do its part to support those hedge
of companies or industries, or that hedge fund managers ny’s assets being stranded by a shift away from the use the possibility for their effects to be hedged. For instance, fund managers wishing to implement responsible invest-
stoke misguided fears about sound companies in order of hydrocarbons. a hedge fund manager wishing to protect against the risk ment, and will soon publish a paper exploring the con-
to profit from the subsequent market reaction. This is of natural disasters occasioned by climate change could fluence of short selling and responsible investment in
not accurate at all. First, such behaviour would in many Those managers wishing to actively create social or envi- take short positions on a handful of insurers to hedge greater depth.
cases be illegal. Second, it would be a profound breach ronmental good, meanwhile, are more likely to engage their exposure.
of professional ethics. Third, doing so would not be a in impact investing. This is a niche strategy in the hedge Those wishing to learn more about AIMA’s work on
sustainable investment strategy, as the market would fund industry, and it involves pursuing a strategy of delib- Those managers wishing to create social or environ- responsible investment should contact Max Budra at
quickly realise what was happening. Short selling is sim- erately investing in companies that create social or envi- mental goods, meanwhile, may wish to use short sell- mbudra@aima.org
ply a means of investing; it is no less moral than any other ronmental good. For instance, a hedge fund manager ing in a more active manner. Rather than simply going
investing technique. could invest in a for-profit company that offers water long on assets that create positive impacts, such man-
purification solutions to rural communities. Conversely, agers could short assets that create social or environ-
a manager could also theoretically look to promote envi- mental harms, operating under the assumption that
ronmental or social change in order to affect the price those harms have not been priced into the asset’s mar-
The Alternative Investment Management of an asset. ket valuation. This allows hedge funds to be far more
Association (AIMA) is the global representative flexible, and potentially far more impactful, than tra-
of the alternative investment industry, with Finally, a hedge fund manager wishing to reconcile the ditional impact funds. For instance, rather than simply
around 2,000 corporate members in over 60 ethical or religious beliefs of their investors with their investing in companies that clean chemical spills, an
countries. AIMA’s fund manager members investment portfolios may opt for the use of ‘socially impact hedge fund could short companies that cause
collectively manage more than $2 trillion in responsible investment.’ This is a screening process by those spills in the first place—increasing their cost Max Budra
hedge fund and private credit assets. which specific assets or asset classes are completely of capital. Similarly, a hedge fund could short com- Associate
excluded from a portfolio. This form of responsible panies that fail to improve their environmental or AIMA
investment is very old, and has historically been driven social practices.

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