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International traders look to Australia to hit on next big short; Westpac targeted

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Soren Aandahl has never travelled so far finding a stock to short.

The co-founder of Glaucus Research flew more than 16,000 kilometres from his base in Austin, Texas, to Australia, where he's looking at companies including commodity producers.

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He's not the only one. From his new firm in London, former Goldman Sachs derivatives trader Ismail Guennouni chose Westpac as his next big short.

If you short a company, you effectively make a bet that its share price will fall. Going long on a company means you expect a rising share price.

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Aandahl and Guennouni are among international traders targeting shares in Australia's $1.7 trillion equity market, where average short-selling levels are already double those in Hong Kong. Aandahl turned his attention down under as part of a broader expansion that includes a foray into Japan last year, while Guennouni is convinced Australia's big banks will be decimated by stricter regulations. 

One prominent local investor is far from surprised at their arrival.

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"The perception from foreigners is that the market is a little dopey and that the corporate regulator is a little soft," said John Hempton, the founder of Sydney-based hedge fund Bronte Capital Management. "You do find frauds here. They make obvious targets."

Australia's securities regulator says short-side analysts are entitled to their views and targeted firms should respond to their allegations in full. It also said it monitors research identifying stocks predicted to fall.

"We encourage companies to publicly address the concerns raised," said Greg Yanco, the senior executive leader for market supervision at the Australian Securities & Investments Commission.

'Follies, frauds and fads'

For Aandahl, who made his name covering Chinese companies listed in the US, the move is the next step after targeting its first Japan short in July. The 36-year-old director of research at Glaucus, who says his team spends as much as 700 hours researching one idea, is also active in Hong Kong, where he tends to highlight stocks he expects to lose most or all of their value.

Glaucus plans to publish a report on at least one Australian company this month or early next month, Aandahl said, declining to identify the targets. He said shorting the country's banks wouldn't be attractive.

"If you look at our track record, for the most part we are industry agnostic," he said in an interview earlier this month. "We short follies, frauds and fads -- that's what we look for."

The perception from foreigners is that the market is a little dopey and that the corporate regulator is a little soft.

John Hempton, Bronte Capital Management

In April 2012, Universal Travel Group voluntarily delisted from the US sharemarket, a year after Glaucus issued a report questioning the Chinese company's financial statements and advising investors sell the stock. In 2013 UTG settled a lawsuit with the US Securities and Exchange Commission.

More recent successful bets include Tech Pro Technology Development, whose shares fell 86 per cent in one day after Glaucus questioned the company's accounting. Tech Pro vigorously denied the claims in the report.

Aandahl's foray into Japan has been tough. Itochu Corp., a trading company, has risen about 30 per cent since Glaucus issued a "strong sell" rating. Itochu strongly denied the criticisms of its accounting.

Shorting Westpac 

Guennouni, also 36, set up Meridian Investment Management Advisory last year to make long and short bets on stocks. After starting his career at Goldman Sachs helping companies to manage risk using derivatives, he moved to Boussard & Gavaudan Asset Management in 2007 and rose to partner at the hedge fund. From 2012 he worked for Occitan Capital Partners designing options strategies.

One of Guennouni's first shorts at Meridian is Westpac. Australian lenders stand to suffer more than global peers as expected changes to regulations on risk-weighted assets dampen profitability, Guennouni wrote in a 46-page short report published last month.

The trade doesn't depend on a hard landing in China or a commodities rout, he wrote. Shares of Westpac, which he sees as the lender most exposed to this risk, may fall from 30 per cent to 50 per cent, he said, without specifying a time frame. Westpac declined to comment.

Widow maker

Betting against the local banks has been so unsuccessful that the trade has been nicknamed the "widow maker." Expectations for a local housing-market crash or a sharp deceleration in China's economy have failed to materialise for bearish investors waiting for lenders' stock prices to slump.

"Most people have been shorting Australian banks as a part of a macro short on China and the economies linked to it," Guennouni said. Ours is "a bottom-up trade, not macro-driven."

Short interest for companies in Australia's S&P;/ASX 200 Index on average accounts for 3.7 per cent of the shares freely traded, compared with 1.8 per cent for stocks on Hong Kong's Hang Seng Index, according to IHS Markit data. That's also higher than the 2.1 per cent on Japan's Nikkei 225 Stock Average and 2.7 per cent for the S&P; 500 Index in the US.

For Chad Slater, co-founder of Morphic Asset Management, Australia "is one of the best places in the world to short -- hands down." It doesn't have transaction taxes like in the UK and Taiwan, and it's easy to find stocks to borrow, he said, a crucial part of the short-selling process. "It ticks every box," he said.

Despite targeting companies in Australia for the first time, neither Aandahl nor Guennouni see broader issues with the market itself.

"We are not finding the droves of what we think are really material misrepresentations, or really rotten companies," Aandahl said. "We think there are a couple of rotten apples."

Bloomberg