Plato's Dr David Allen on its unsung hero driving outperformance

Simply look at how equities have recently responded to overwhelming geopolitical and economic turmoil by posting new record highs.

For many, betting against the market can feel like an affront to the principles on which the entire system is built. But the reality is markets move in two directions, and that can be an edge for investors who understand conviction does too.

For Dr David Allen, Plato Investment Management's Head of Long/Short Strategies, shorting is a strategic investing tool that fuels real returns, not simply a way to mitigate risk.

"Shorting is a critical source of generating outperformance," says Allen. "Whereas some long/short managers will use shorts to fund or hedge longs, all of our shorts are in the portfolio because we believe they will significantly underperform."

In a market where stretched valuations and mispricings are common, shorting can be an offensive weapon that adds a new dimension to a fund's strategy.

As Allen told my colleague Chris Conway back in October last year, "in markets this distorted, long/short strategies are uniquely positioned to profit from the dislocations."

It's a strategy Plato has used to great effect. Shorting has contributed roughly 30% alpha to the Plato Global Alpha Fund since its inception in 2021. 

In that time, the fund has returned a net 22.5% p.a., while its benchmark, the MSCI World Net Returns Unhedged Index, has returned 12.4% p.a..  

Given that Plato aim to maintain a 150:50 ratio of long exposure to short exposure, it shows the outsized impact shorts have in generating excess returns for the fund. 

Finding the stocks to short

Plato notably employ an in-house Red Flag model, where companies are assessed against more than 150 risk factors that, taken together, can point to a stock's potential underperformance in future. 

It's a model Plato runs on more than 20,000 global companies, and which is used as an initial screen to identify potential short candidates. Plato research shows a company that triggers eight or more of its 150 red flags then underperforms the market by 20% over the next year. 

"A high number of Red Flags is a necessary, but not sufficient, condition for Plato to initiate a short," says Allen. 

Any potential short candidate will also be assessed on a number of fundamentals to reduce the risk of the trade going against the fund. 

"The ideal short will also have a stretched valuation, poor organic cashflow growth, and negative sentiment."

"Sentiment is critical to ensure that we are not standing in the way of an avalanche of speculative investors. We prefer to miss the first leg down than suffer as the stock continues to make me new highs."

When to close the short

Executing shorts is as much about knowing when it has run its course as it is identifying the opportunity in the first place, and there are numerous reasons Plato will choose to close a short. 

One is simply that the initial cause for the short - a company triggering eight red flags - no longer applies. 

Plato's red flag model offers a robust, data-driven approach to shorting, and that means paying attention when it tells you a company has cleaned up its act.

He points to an infamous example - German automaker Volkswagen, which was engulfed in an emissions scandal in 2015. 

"Vokswagen had 14 Red Flags going into their emissions-cheating scandal, but now only have a small handful."

Other reasons for closing a short may be a shift in fundamentals or market narratives, says Allen.

"It could be the stock has fallen so much it is now good value. Sometimes sentiment will improve, for example sell-side analyst may turn more bullish."

There's also a wariness over getting caught offside if a stock reverses. 

"Another reason is that the stock has fallen so much that there is a risk that if there is even a little bit of positive news, the stock could rally aggressively. It would be unusual for us to short a company for example that had already fallen 80%."

Shorting in the current environment

While market volatility and corrections ostensibly widen the playing field for potential shorts, Allen says Plato look to maintain a fairly strict framework around its long and short exposures. 

"150% long, 50% short is where we like to run the portfolio."

In cases of extreme volatility, Plato may instead limit its overall exposure, whilst always maintaining net exposure in line with the market. 

"If there is a large market dislocation, for example the Ukraine invasion, or the Liberation Day Tariffs announcement, we may de-risk the portfolio by reducing exposure to say 140% long, 40% short," says Allen. 

"Critically we always maintain net exposure to the market of 100%, i.e. 140% minus 40% = 100%. We believe in time in the market, rather than timing the market."

While we find ourselves in the midst of another prolonged period of market volatility right now, Allen says it had previously been a difficult shorting environment as sentiment overshadowed fundamentals in certain parts of the market.

"The backdrop for shorting was challenging in the last six months of 2025," he says. "Pre-revenue, unproven businesses were all catching a bid." 

"There was a re-emergence of the meme stock phenomenon with names like Krispy Kreme and Go-Pro seemingly divorced from fundamentals. I have seen junk rallies like this in my career more times than I care to remember. They are typically painful, but short lived."

But the landscape has corrected itself somewhat in the face of the conflict of the Middle East, and shorts are again driving alpha for the fund. 

"Sure enough in the last two months our shorts have again been adding significantly to performance."

Even in a market where logic often takes a backseat, sanity generally prevails. Markets move in two directions, and that means opportunities can as well.