Billions of dollars in new short positions were flattened against UK names

According to technology and data analytics firm S3 Partners, the short selling market is alive and well, with £28.9 billion worth of positions currently active in the UK.

June delivered another surge, with a further £2.4bn of shares shorted to offset an overall £2.5bn share price decline as short sellers bolstered their winning positions.

A look over the FCA publicly available table from active short positions, many recognizable names can be seen across multiple sectors. The lion’s share of positions are in sectors most vulnerable to the ongoing pressures of the cost of living crisis.

Although shorting isn’t just about forestalling stock price declines, Tim Service – who manages the Jupiter UK Specialist Equity fund – says a combination of high valuations and bubbly markets makes it more likely to find short positions, which in absolute terms will fall significantly.

“In my fund, some short positions are down 50% or more this year,” says Service, who sees opportunities in three broad categories:

• – structurally challenged companies with minimal pricing power,
• – Newer business models not yet achieving profitability, and
• – Market “darlings” of the past decade

Service offers Kingfishers and Naked Wines as respective examples of the first two categories, explaining the opportunity he sees in the third: “These stocks are usually objectively good companies, mostly high-margin, well-managed, maybe some tailwind for structural growth , high returns on capital and good cash conversion.

“However, over the last decade of very low bond yields, valuations have been driven to staggering levels. They’ll likely weather the coming downturn just fine, but multiples can still shrink significantly more than their more mundane peers. Halma is a good example.”

look at the finances

Ironically, Jupiter Asset Management is one of several high-profile financial stocks currently being shorted. It appears in the FCA table alongside Abrdn, Hargreaves Lansdown, Investec and Quilter to name a few.

“Even if one believes that the market will remain strong in the medium term, one could expect investors to react, which means that money will be pulled out of the market, either directly through the sale of holdings or the withdrawal of capital from funds.” explains Andrea Gentilini, Managing Director and Head of SEI Novus, a data management platform for institutional investors.

She argues that this could hit some of the biggest names hardest.

“Big companies must continue to fall, and it may be that the name and branding of well-known companies have helped mask the cracks that are appearing in the market – until now,” she adds.

“Financial firms in particular could face high risks associated with lower repayment rates, higher interest rates depressing lending, higher costs of raising capital and lower returns on their investment businesses in the face of the bear market.”

However, short selling opportunities may vary within financial services sub-sectors. Jupiter’s Service has looked beyond the headlines and suggests that current short selling activity tends to reflect longer-term trends.

“Most of the big disclosed shorts here are actually in sub-sectors like investment platforms where competition has gotten tougher,” he says.

“From the data I’m looking at, I don’t think there are any significant short positions at banks and specialist lenders – rising rates are not unfavorable for them and the sector is now fairly well capitalized against a potential recession.”

Find the next big short

As a major financial market, the UK benefits from significant analyst coverage. According to transaction data provider 2iQ, as of June 24, 87 managers were shorting the UK market. The three most active managers were GLG Partners, Marshall Wace and Blackrock with 44, 33 and 26 positions respectively.

Naturally, this has meant that short positions in UK equities have taken the market cap spectrum down into the FTSE 250 and beyond.

2iQ financial analyst Suhaib Haider says: “Fund managers and investors can identify stocks from small and mid-cap categories where price deviations are still possible even in a well-researched market.

“Also short circuit [large cap stocks] requires a huge fee that short sellers typically pay to the lender of the shares.”

At the top of the market, where every move of the FTSE 100 giants is closely watched, there can still be scope for short selling.

A healthy level of skepticism about analyst notes is required here, says Service, who cautions against forgetting the sell-side, which is largely focused on finding buy ideas.

“Most stockbrokers have an investment banking business, so they don’t like to write anything negative about potential clients,” he says.

“Most of their investment clients are long-only, so they don’t like reading sales notes about their own investments. As a skeptical sell-side analyst, you don’t have much to offer in your career. It is a more fertile hunting ground for short ideas than for long ones.”

The human element cannot be ignored either, as one anonymous trader points out the herd mentality to which a well-covered market like the UK can be prone.

“Few analysts want to take the career risk of sticking their necks out, and this creates price anomalies that can be exploited by looking at things like earnings dynamics,” says the trader.

“Human emotions like fear and greed also create anomalies that create opportunities when investors make irrational decisions – leading to inefficient pricing and alpha opportunities.”

By Jon Yarker, 30 Jun 22