Low-Quality Rally Still Rolling? The...

Low-Quality Rally Still Rolling? The Challenges for Short Selling

Long Short Review of the First Quarter of 2021 | KayneCast 153

June 14, 2021

Chris Wright, manager of KAR’s Long-Short portfolio, believes that the first quarter of 2021 was a continuation of the low-quality rally that began in November 2020, after the first vaccine announcements:

  • Companies with return on equity (“ROE”) greater than 20% appreciated 8.5% in Q4 2020 and another 3% in Q1 2021, while companies with negative ROE grew 29% in Q4 and another 9.8% in Q1.
  • Investment-grade companies appreciated 11.7% in Q4 2020 and 6.3% in Q1 2021, while below-investment-grade companies grew 25% and 9.3%, respectively.

In addition, asset bubbles have formed as companies that should have been restructured before or during the pandemic were able to kick the can down the road by taking on more debt. This makes the current environment challenging for short selling, especially when it’s focused on low-quality businesses.

Key Contributors and Detractors in Long Short

To learn more about the top 5 contributors and detractors in KAR’s Long Short Portfolio for Q1 2021, listen to the podcast above.

2021 — Too Far, Too Soon?

It took the Russell 3000 only five months to fully recover from the recession caused by COVID-19, in contrast to the more than five years it took to recover from the last financial crisis. This speedy recovery, coupled with the fact that some market barometers such as the cyclically adjusted price-to-earnings ratio and the market cap to GDP ratio are at multi-year highs, makes Wright wonder if we’ve come too far, too fast.

What does this mean for Wright’s long-short investment strategy?

  1. Little change on the long side — We remain focused on seeking companies with competitive advantages at reasonable prices.
  2. An enduring mantra for the short side — We continue to proceed with caution.

KAR will continue to eschew participating in the type of heavily shorted names that caused attention-grabbing short squeeze situations earlier this year and try to mitigate risks in our short book by avoiding leverage and speculative derivatives like SWAPs.


Learn more about our long-short portfolio today. 

This information is being provided by Kayne Anderson Rudnick Investment Management, LLC (“KAR”) for illustrative purposes only. Information contained in this material is not intended by KAR to be interpreted as investment advice, a recommendation or solicitation to purchase securities, or a recommendation of a particular course of action and has not been updated since the date of the material, and KAR does not undertake to update the information presented should it change. This information is based on KAR’s opinions at the time of the recording of this material and are subject to change based on market activity. There is no guarantee that any forecasts made will come to pass. KAR makes no warranty as to the accuracy or reliability of the information contained herein.