Billions in new short positions levelled against UK names

Uncompromising macroeconomic environment has started to expose unsustainable valuations

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The shorting market is alive and well, with £28.9bn of positions currently active in the UK, according to technology and data analytics firm S3 Partners.

June delivered a further increase, with an additional £2.4bn of stocks shorted to offset an overall stock price fall £2.5bn, as short sellers backed up their winning positions.

Glancing over the FCA’s publicly available spreadsheet of active short positions, many recognisable names can be seen across several sectors. The lion’s share of positions are in sectors most vulnerable to ongoing cost of living crisis pressures.

Though shorting is not just about getting ahead of stock price declines, Tim Service – who manages the Jupiter UK Specialist Equity fund – says a combination of high valuations and frothy markets make it more likely to find short positions that will fall significantly in absolute terms.

“In my fund, we’ve had a number of short positions fall 50% or more this year,” says Service, who sees opportunities in three broad categories:

  • – Structurally challenged businesses with minimal pricing power,
  • – Newer business models yet to achieve profitability, and
  • – Market “darlings” of the past decade

Offering Kingfishers and Naked Wines as respective examples of the first two categories, Service explains the opportunity he sees in the third: “These stocks are usually objectively good businesses, mostly with high margins, well managed, maybe some structural growth tailwinds, high returns on capital and good cash conversion.

“However, over the last decade of very low bond yields, valuations were bid up to eye-watering levels. They are likely to navigate the coming downturn fine, but multiples can still contract significantly more than their more pedestrian peers. Halma is a good example.”

Looking over the financials

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

“Even if one believes the market will remain strong in the medium term, they could be expecting investors to be reactive, meaning 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.

He argues this could hit some of the biggest names the hardest.

“Large firms have farther to fall, and it could be that the name and brand of well-known firms have helped to paper over the cracks that are appearing in the market – so far,” he adds.

“Financial firms, particularly, could be facing high risks associated with lower repayment rates, higher interest rates pushing down lending volume/costing more to raise capital, and fewer profits from their investment businesses given the bear market.”

That said, shorting opportunities may differ within financial services sub-sectors. Jupiter’s Service has looked beyond the headline data and suggests current shorting activity is more reflective of longer-term trends.

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

“From the data I see, I don’t think there’s significant short positioning in banks and specialist lenders – rising interest rates aren’t unhelpful for them, and the sector is now pretty well-capitalised against a potential recession.”

Finding the next big short

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

This has naturally led shorters of UK stocks down the market cap spectrum, into the FTSE 250 and beyond.

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

“Also, shorting [large cap stocks] requires a huge fee that short sellers normally pay to the lender of the stocks.”

At the top of the market, where FTSE 100 giants’ every move is intensely watched, there can still be scope for shorting opportunities.

Here, a healthy level of scepticism is required for analysts’ notes, says Service, who warns against forgetting the sell-side is largely set up to find buy ideas.

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

“Most of their investment clients are long-only so they don’t like reading sell notes about their own investments. There is not a lot of career upside on being a sceptical sell-side analyst. It’s a more fertile hunting ground looking for short ideas than long ideas.”

The human element can also not be ignored with one anonymous trader pointing out the herd mentality a well-covered market like the UK can be susceptible to.

“Few analysts want to take the career risk of sticking their neck out and this creates anomalies in pricing that can be taken advantage of by looking at things like earnings momentum”, the trader says.

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

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