The inside story of how short seller Carson Block made a killing this year, even as the market made life miserable for many investors

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The inside story of how short seller Carson Block made a killing this year, even as the market made life miserable for many investors

carson block

REUTERS/Benjamin Myers

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Short seller Carson Block, founder of Muddy Waters Capital, says he's managed to dodge the wild ride in equity markets that have put many of his hedge fund peers in the red.

"We're happy with how things have gone this year," he said in an interview. While he declined to quantify the fund's performance, a person familiar with the matter said Muddy Waters has posted returns this year of about 18%.

It's not a bad result for what has been a brutal year for many equities traders. October was a bloodbath for stock markets, and few felt the pain like hedge funds, which turned in a rocky month for the ages.

"Because we trade around short activism, we're not really correlated to the market," he said. "Our strategy is slightly negatively correlated to the market. The only catch here is that for a purely short activist strategy, it's not super scalable."

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This year Block targeted Canadian insurance firm Manulife; a London semiconductor company called IQE; and Chinese tutoring company TAL Education Group. The stocks all plunged when he released his reports.

Read more: Hedge funds just suffered through their worst month in 8 years - here's why their struggles could just be getting started

Muddy Waters is not alone among short-seller peers doing well in 2018. Ben Axler's Spruce Point Capital is up 25% so far this year, while Eiad Asbahi's Prescience Point Capital Management has posted gains of about 47% in the first nine months of this year, people familiar with those returns told Business Insider. Reuters has reported that Sahm Adrangi's Kerrisdale Capital was up 45% through the end of September.

"Obviously, we do take into account macro factors," Block said. "We try to hedge the beta of our trades, somewhat isolate for that and really try to focus on the idiosyncratic aspects of the name."

Block is best known for calling out fraudulent Chinese companies, shooting to fame after calling timber company Sino-Forest a fraud in 2011. The company has since filed for bankruptcy. After he called out Rino International and China MediaExpress, they were de-listed from major US exchanges.

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Some powerful players in China didn't appreciate his line of work, and Block, a Mandarin speaker, left China for San Francisco in 2010, claiming he was chased out by "gangsters." He now finds companies to short all over the world.

Leveraged loans

Block also makes bearish bets on stocks via corporate bond markets. One strategy is to buy a bond, then use the repayments to help fund the purchase of long-dated contracts - or puts - that pay out when the stock declines.

"It's a synthetic short position in the stock," he said. He might consider ramping up that strategy if a disconnect emerges between loans and stocks, for example if the loans get cheaper and thus offer more funding to buy more puts, before the equity market catches up.

"There are some concerns about the leveraged loan market," he said. "If we didn't have equity hedges on, its something we'd be really concerned about."

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Souring on Europe

"Europe has a lot of structural issues that promotes poor corporate governance," he said, including a more deferential investing culture relative to that of the US. "Presumably, that creates a target rich environment, but in Europe there just isn't the protection of free speech the we have here in the US."

He continued: "That presents issues when your business model is speaking truth to power. There's a temptation for power to be misused to punish the speakers unduly when the scrutiny should be on the companies."

Block said Muddy Waters hasn't initiated a short against a European company since April 2016, when he accused German ad firm Stroeer of overstating its cash flow.

"Never say never," he said of targeting Europe again. "I'm always watching."

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