The Old World of Shorting Stocks is Gone
Historically, hedge funds justified their high fees (2% management + 20% performance) by claiming they could generate returns by playing both sides of the market, not just buying stocks. The key differentiator was short selling:
Buying stocks could only profit when those stocks went up
Hedge funds could profit from both sides: long undervalued stocks, short overvalued ones
Good short sellers demonstrated deep fundamental analysis - finding accounting fraud, business model flaws, or overvaluation that others missed
This was supposed to provide better risk-adjusted returns and downside protection
Why That World Is “Gone”
1. Structural Market Changes
Passive investing dominance: Money flooding into index funds/ETFs creates indiscriminate buying that lifts all boats, including overvalued stocks that are supposed to be good shorts.
Central bank intervention: A decade+ of QE and low rates meant “don’t fight the Fed” - shorts got crushed as liquidity lifted everything.
2. The Short Squeeze Era
GameStop/AMC showed coordinated retail traders could intentionally target and destroy short positions.
Increased transparency (13F filings, social media) makes short positions more visible and vulnerable.
The asymmetric risk (100% max gain, unlimited losses) became even more dangerous.
3. Crowding & Information Efficiency
Too many smart people chasing the same obvious shorts.
Information spreads instantly; by the time a short thesis is clear, it’s already priced in or crowded.
The “easy” shorts disappeared as markets became more efficient
4. Execution Challenges
Share borrow costs skyrocketed for popular shorts.
Timing became everything - being right but early is the same as being wrong.
The Exception - Volatility Funds
Interestingly, volatility-focused hedge funds represent a notable exception to this trend. Unlike traditional equity long/short funds, vol funds continue to generate profits from both sides of the market:
Different market structure: Volatility markets aren’t driven by passive flows or meme stock squeezes - they’re driven by institutional hedging needs and options market mechanics.
Structural opportunities persist: Retail investors systematically overpay for lottery-ticket options, while institutions consistently need volatility hedges, creating exploitable mispricings on both sides.
True non-directionality: Vol funds profit from volatility itself - whether markets go up or down violently, or grind sideways - rather than needing to pick winning longs and losing shorts.
Less crowded: These strategies require specialized expertise and infrastructure that fewer managers possess.
Funds that sell volatility premium, run dispersion trades, or employ tail-hedging strategies can still meaningfully profit from being “short” (selling overpriced options) while also capitalizing on long volatility opportunities during dislocations.
In other words, while traditional short selling of equities has become largely unworkable, shorting volatility and trading volatility bidirectionally remains a viable source of hedge fund alpha - perhaps one of the few genuinely differentiated strategies left that justifies the fees.
