Short selling campaigns in China | China Accounting Blog | Paul Gillis

Short selling campaigns in China

China has been a major focus in recent years for short selling research firms.  Short sellers make money by borrowing stock, selling it, and hoping to repurchase and return the borrowed stock at lower prices. Short selling campaigns put short positions into place, and then publish reports about the companies that often allege fraud or overvaluation. The campaigns often lead to a sharp decline in stock prices, investigations, and even delistings, giving the short sellers significant profits. 

I am planning to teach a course this fall at Peking University that will focus on short selling campaigns against Chinese companies. I want to share some interesting data about the history of short selling campaigns against Chinese companies. I obtained this data from the excellent database offered by Activist Shorts Research. Founder Adam Kommel kindly gave me access to this database.  I highly recommend that any fund investing in Chinese equities subscribe to it. 

Here is a table I extracted from the data:

As you can see there have been 145 campaigns against Chinese companies since 2009. Some companies faced multiple campaigns by different research firms. Returns are measured from the commencement of the campaign to the campaign end date, or the present if the campaign continues. I calculated the average campaign return simply by averaging individual campaign returns (i.e. my number is not weighted by market capitalization). Positive returns mean the stock price went down and the short sellers profited. 

Muddy Water’s 2010 campaign against Orient Paper is often thought to mark the commencement of the reign of the short sellers with Chinese stocks (although there were a few earlier campaigns). 2010 was an amazing year for the short-selling analysts. Each of the 18 campaigns was profitable, yielding an average return of 82% and many leading to complete wipeouts of the target.  

The big year for campaigns was 2011, with 59 attacks yielding an average return of 52%. Some of the most spectacular short campaigns, including Sino-Forest, happened that year.  But a few campaigns failed, sometimes because the company went private (Focus Media, Harbin Electric) or was able to shake off the allegations (Qihoo 360).  

By 2012, the market turned bleak for short sellers. The number of campaigns dropped to 18 and they lost an average of 36%. The year 2013 was no better, with 14 campaigns losing an average of 37%. Perhaps the low hanging fruit was gone, and perhaps the companies learned how to better defend themselves. I need to spend some time digging into the details.

If you thought two bad years would stop the short campaigns, you would be wrong. They returned with 27 campaigns in 2014 winning an average return of 26%. Six campaigns in 2015 have already returned 13%. There has been more action in Hong Kong lately; I will address that in a later post. 

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