Marty Fridson, chief high-yield strategist at Merrill Lynch, has spoken out in defense of short sellers who were the subject of griping attributed to Bill Gross in a recent article published in Barron's. The activity of short sellers in the credit market has occasioned a number of complaints among mutual fund managers, and Fridson's defense drew notice. According to the article, Gross accused hedge funds of driving down bond prices, provoking downgrades and forcing selling from investment-grade money managers. Gross did not return a call seeking comment.
Fridson argues that ratings agencies do not downgrade companies in response to a decline in the prices of their bonds. "I defy anyone to demonstrate that that has happened once in history," he says. He likens the relationship between price declines and ratings downgrades to the chicken-and-egg question. "Proving a cause-and-effect relationship between yield rises and rating downgrades would be difficult, considering that credit deterioration ought to cause both to occur," he wrote in a recent research note.
The appearance of short sellers in the high-yield market is a cyclical phenomenon, which occurred most notably in 1989-90, says Fridson. "When we get into a thin and basically vulnerable market, risk-oriented investors who are not year-in-year-out players in the high-yield market become more active. If you define that as a problem, I'm at a loss to offer a solution," he says, likening criticizing short sellers to "shooting the messenger."
Brendan White, high-yield portfolio manager at Fort Washington Investment Advisors, says that while he is basically in agreement with Fridson, he adds one caveat. "To the extent that short selling causes a security to trade down to an inappropriate level, it could reduce the firm's access to capital, which could affect its creditworthiness."