Managed fund researcher Standard & Poor's has placed 57 funds from 25 managers with shorting capacity "on hold" after the Australian Securities and Investments Commission placed a ban on short selling last week.

The ban is in place for 30 days while the regulator tightens existing laws and forces greater transparency.

British and US authorities had already banned short selling of certain financial stocks. Australian regulators and the Federal Government came under pressure from institutions, such as Macquarie Bank, which have been under attack from short-selling hedge funds.

The regulator feared Australian companies would become targets for overseas hedge funds if it did not follow suit.

Simon Scott, a S&P fund analyst, says market-neutral funds, which allocate equal portfolio portions to long and short positions, will be affected much more than those that are mostly long-only.

Managers with limited short exposure, such as Portfolio Partners, say their investors have nothing to worry about.

Richard Dickson, who runs Portfolio Partners' High Growth Shares Trust, says the fund only invests in shorts opportunistically. He says that since the heavy market declines, the advantages for shorting are gone. "There are not as many intrinsically overvalued stocks anymore, whereas 12 months ago there were many."

If the ban is extended longer than a month it could create problems for long-short managers and their unit holders.

Many managers have made good money from correctly calling the fall of companies' share prices. Not being able to short individual stocks would mean market-neutral funds that do a lot of shorting would not be able to do so and would have to hand money back.

In the past few years Australian fund managers have added short selling to their strategies, launching funds with substantial shorting capability.

Most fund managers still invest "long"; that is, they hold shares for the longer term.

How the ban will affect funds depends on how often it trades, its reliance on short selling and whether the fund is restricted to investing in Australian shares, where the ban on shorting is total.

Craig James, the chief equities economist at Commonwealth Securities, says that the actions taken by central banks across the globe to ban short selling have been essential in helping to restore investor confidence.

"The practice of short selling may have its virtues but the fact is that it has been poorly regulated and, in turn, abused by hedge funds and other large investors."

James says ordinary investors have been hurt by the short-selling practices of hedge funds with significant market power. He says it is up to the proponents of short selling to defend it. "If the practice is to continue, then much greater oversight and transparency is required," he says.

"Despite large players such as hedge funds claiming short selling is an essential tool, if it was exposed to much greater scrutiny, especially public scrutiny, usage would likely wane.

"The fact is that small individual investors can't engage in short-selling. They do what all investors do more generally if they think a stock is overvalued - they don't buy the stock or sell existing holdings and invest in other companies instead."

Graeme Miller, the head of investment consulting at Watson Wyatt Australia, which gives investment advice to some of the biggest super funds, says the effects of the ban on the performances of super funds will be negligible. He says super funds have only a small exposure to short-selling strategies and that the benefits of the ban far outweigh the negatives as it will help restore stability to the sharemarket.

Short selling: what is it?

Short selling is a technique where money can be made if a share price falls. It has obvious appeal in falling markets.

"Long" investing - or investing for the long term - is the more typical approach to investing.

With short selling, the fund manager borrows shares of the company it wants to short, from other institutions such as superannuation funds.

Legal ownership of the shares remains with the super fund and the borrower of the shares pays a "rent" fee to the fund.

The fund manager sells the shares and pockets the proceeds.

Then, once the share price falls, they buy replacement shares (covering the short position) and return the shares to the super fund.

The unit holders in the short-selling fund profit from the difference in the two prices.

High debt targeted

The global financial crisis has been worsened by short-selling hedge funds that have been accused of putting out false rumours about the financial health of companies they target. Companies carrying high levels of short-term debt have been particularly vulnerable to hedge funds.

A contributing factor to the recent troubles of ABC Learning Centres, Allco Finance Group and Centro was that some of their directors had big margin loans over their companies' shares. With margin loans, the lender's minimum loan-to-valuation ratio must be maintained. When share prices in these companies tumbled, lenders called on the directors to restore the ratio (either by coming up with cash or selling shares). The mass selling of shares that followed put further downward pressure on their prices.