Saving Jim Chanos

Everyone needs saving, even Jim Chanos. A man renowned for his short positions—both in the market and the one he received from Elon (if that actually happened), which I’m sure Jim would have kept as a memento. If hedge fund managers are a rare breed, then short hedge fund managers are the rarest of them all. Only a handful, like Carson Block, and Hindenburg Research, have made some "name" for themselves. And then there's Chanos, who closed his fund. He's also a professor of finance at Yale. I admire these people. I admired Prechter, who some labeled a permabear. But over time, as the market continues to defy expectations, it’s no longer just about the courage to stand alone; it’s about accepting the irrationality of the market—a phenomenon that cannot be timed. Keynes, wherever he is (heaven, hell, or somewhere in between), doesn’t even bother laughing anymore. All we hear is the echo of his thought: “I told you so!”

Markets may be irrational, but regulators who ban short-selling, especially when the market is on the brink of correcting itself, make it a rigged game against shorts. It’s as if they’re saying, “If you short, we’ll crush you.” An emerging market broker once advised me, “Don’t short frontier markets; they’ll whipsaw you.” He was among that rare breed who, like Irving Fisher, talked about the permanently high plateau in 1929. Rarity is indeed mercurial. Sometimes it flips, and heroes become zeroes. Take Alfred Cowles, for instance. In 1929, he stood at the top, screaming “buy!” When the market caught him off guard, he concocted the passive investing narrative—the idea that markets can’t be beaten—and then the story took root.

But today, it’s about saving Chanos—the man I admire and the man who didn’t read my email before he closed his fund. But that’s okay. I’m an admirer, and I want to find a way to make shorting fashionable again, without upsetting regulators or Elon. I certainly don’t want to be on Elon’s bad side. In fact, I told Flori that I believe Elon and I could be friends, since he’s against passive investing and we are transforming passive. As I see it, the change should come to fruition in my lifetime. If not, I have backup plans with my 7-year-old. Back to Jim.

Finding a way to short without getting burned isn’t a trillion-dollar opportunity, but it’s definitely worth billions—a chance where players like Chanos shouldn't have to struggle to raise assets. Of course, if I were raising assets for my hedge fund, having Chanos by my side would be invaluable, hence this open letter. Some of you who’ve followed my work since I started writing about markets in 1998 might be familiar with my forecasting background and my early musings on short inverses.

There’s a better way to build an inverse index, and it has a lot to do with the objective at hand. Inverse indexes often lose all the money because markets tend to stay bullish, and when bear markets do come, they vanish like lightning and the compounding losses betting against a market refusing to fall does the rest. The challenge is how to extend bear markets long enough to capture a profit. Waiting for a bear market is like waiting for the perfect trade — it rarely happens. This is something I’ve learned during my little experience tracking markets. Hence, my recent views on perpetual bulls. If markets are in a perpetual bull, and bear markets are ephemeral, then even if bears were real, the likelihood of top large-cap companies—FANGs, DANGs, NANGs—falling 90% is low (though Taleb might disagree). But I’m not willing to wait another 25 years for that event, nor do I have the funds to buy cheap out-of-the-money options. I learned about the odds of succeeding with puts in the first year of my capital market career.

So, how do we short without shorting? The answer is indeed simple, and for me, this isn’t theory—I do this for a living. So here goes: Market capitalization is a false narrative, even if the world and SPIVA try to convince you otherwise. A real smart beta can generate risk-weighted excess returns. If it’s truly real, a smart beta process is scientific, systematic, and replicable (SSR). This is detailed in the AlphaBlock 2018 White Paper . If it’s SSR, then it’s also invertible, which means for every sustainable smart beta, there’s a sustainable dumb beta. This means if you can design a consistently outperforming, alpha-generating process, you can also design a consistently underperforming process. Once you have a consistently underperforming process—which can be built in many ways: a forensic way, a negative ESG way, a poor fundamental quality way, an indexed way, or a combination thereof—what remains is the systematic risk.

The risk that markets are irrational longer than you can prove profitability to your sponsors, or the risk that markets are in a perpetual bull, or the risk that market declines are fleeting. This systematic risk can be addressed by buying the market against the underperforming portfolio. The question then becomes: how good is your underperformance? If it’s solid, you can capture 10% annualized returns at a fraction of market volatility. If it’s brilliant, you can capture 20% annualized returns at a fraction of market risk. This isn’t just a concept; it’s the future—a future where capturing negativity is about pitting it against the market. The strategy only works if you can truly isolate and Index your short selection process. You have to index the ideas, demonstrate their workability, and then transform it into a long-short strategy—where you sell dumb and buy the market, or even sell dumb and buy smart.

Isolation is the only way to survive a short business: by indexing it and reducing risk through a long-short transformation. I’d be happy to pitch this to Chanos if you’re in touch with him. Or just tell him to check his email.