The paper quantifies how short selling can contribute to increasing the cost of capital for high-emissions public companies and can serve as a tool to incentivize corporate management to take more sustainable approaches. It also demonstrates how short selling can be an effective tool to hedge against the portfolio risks associated with the climate transition. For short selling to realize its full potential, the report argues that ESG metrics should recognize that short selling has a different impact in a portfolio than long positions.
“The alternative asset management industry can play an important role in helping achieve ESG goals,” said MFA President and CEO Bryan Corbett. “Short selling is an essential component of healthy functioning capital markets, promoting price discovery and uncovering corporate fraud. Our report provides quantitative evidence that short selling can be an important tool to incentivize corporations to take ESG into consideration.”
Key findings from “The Use of Short Selling to Achieve ESG Goals” include:
- Short Selling can be an Important Tool to Help Advance ESG Goals. To analyze the effects of short selling, MFA estimated the effect on the cost of capital and total capital allocation when investors hedge climate risks by shorting emissions-heavy public companies. The analysis finds that short selling has the potential to reduce capital investment in the most emissions-heavy publicly traded companies by 3-8%.
- Incorporating short selling as part of an ESG-focused investment strategy can advance carbon reduction goals while maintaining investment performance for investors. MFA demonstrates concretely that shorting can be used to hedge climate risks through a numerical example using a climate risk-neutral portfolio. The analysis shows that taking short positions in carbon-heavy stocks is an effective mechanism to hedge climate risk.
- To realize the full potential of short selling as an ESG tool, short positions of a high-emissions company should not be treated the same as long positions when evaluating the ESG risk of a portfolio. The paper explains that if ESG metrics do not accurately reflect the economic exposure a portfolio has to underlying ESG factors, the metrics will not serve as reliable economic indicators. As such, short positions must be appropriately accounted for by counting them differently from long positions.
The full report can be found here.