Written by Callum Abbot

March, 2020

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Extending the alpha opportunity in UK equity

When fund managers have a positive view on a stock, they can buy it and build a position as large as their liquidity and risk parameters allow. In many cases, this can be many times the weight of the stock in the index, significantly increasing the potential to generate alpha (but also the risk of a larger impact on the fund’s performance).

But long-only managers can only express a negative view on a stock by not holding it. The potential for long-only managers to generate alpha from their negative views is therefore limited to the weight of the stock in the index.

This constraint on long-only managers is particularly acute in the UK, where the vast majority of stocks on the FTSE All-Share index have small index weights. Remarkably, even before the 100th largest stock, the index weight drops below 20 basis points. It may surprise investors that many well-known stocks with international operations, such as NMC Group, are small in terms of index weight.

Source: J.P. Morgan Asset Management, Bloomberg as of 31 December 2019. The securities above are shown for illustrative purposes only. Their inclusion should not be interpreted as a recommendation to buy or sell. Past performance is not a reliable indicator of current and future results.

Consider the performance of the FTSE All-Share in 2019: of the 102 stocks that underperformed the benchmark by 20% or more, 64 were small caps, 26 were mid-caps and 12 were large caps. Although different years might have given a different picture and the past is not a reliable guide to the future, long-only managers, in 2019, would not have been able to generate much alpha from simply not holding these stocks. Given 98% of UK equity managers are long-only, most UK equity funds are potentially missing out on a differentiated alpha opportunity because they cannot short stocks.

Increased alpha potential from shorting

In contrast to most other UK equity funds, the JPM UK Equity Plus Fund does have the ability to short stocks. Shorting gives the fund the ability to extend underweight positions and increase the potential to generate alpha from stocks we do not like.

Let’s take NMC Group, in 2019, as an example, which is a stock that we had a negative view on. In addition to not owning the 11 basis points of NMC in the index, the JPM UK Equity Plus Fund topped up the underweight position with a short position of roughly 90 basis points. This total 1% underweight increased the potential alpha generation by a factor of 10 compared to a long-only manager who would be limited to an underweight of 11 basis points. As a result, the Fund generated 52 basis points of alpha from this position, or about 10 times more than a long-only manager that did not hold the stock. 

The FTSE All-Share has a few very large stocks, but the vast majority have small index weights. Only by shorting can fund managers who have the skill to identify the worst stocks express negative views on these many small positions.

For more about how shorting can increase performance, see our related articles in UK Edge.

JPM UK Equity Plus Fund Investment Objective

To provide long-term capital growth through exposure to UK companies by direct investments in securities of such companies and through the use of financial derivative instruments (derivatives).

JPM UK Equity Plus Fund Risk Profile

  • The value of equity and equity-linked securities may fluctuate in response to the performance of individual companies and general market conditions.
  • The Fund invests in securities of smaller companies, which may be more difficult to sell, more volatile and tend to carry greater financial risk than securities of larger companies.
  • The Fund can use sophisticated investment techniques that differ from those used in traditional equity funds.
  • There is no guarantee that the use of long and short positions will succeed in enhancing investment returns.
  • The Sub-Fund uses financial derivative instruments for investment purposes. The value of financial derivative instruments can be volatile and may result in gains or losses in excess of the amount required initially to establish a position in the derivative. The ACD is required to disclose in Appendix A of the Prospectus the sum of the gross notional exposure of the financial derivative instruments used (including those used for hedging or efficient portfolio management) as the expected level of leverage. However, this figure does not take into account whether the instrument increases or decreases investment risk and so may not be representative of the overall level of investment risk in the Sub-Fund.
  • The possible loss from taking a short position on a security (using financial derivative instruments) may be unlimited as there is no restriction on the price to which a security may rise. The short selling of investments may be subject to changes in regulations, which could adversely impact returns to investors.
  • The single market in which the Fund primarily invests, in this case the UK, may be subject to particular political and economic risks and, as a result, the Fund may be more volatile than more broadly diversified funds.

For Professional Clients only – not for Retail use or distribution

This is a marketing communication and as such the views contained herein do not form part of an offer, nor are they to be taken as advice or a recommendation, to buy or sell any investment or interest thereto. Reliance upon information in this material is at the sole discretion of the reader. Any research in this document has been obtained and may have been acted upon by J.P. Morgan Asset Management for its own purpose. The results of such research are being made available as additional information and do not necessarily reflect the views of J.P. Morgan Asset Management. Any forecasts, figures, opinions, statements of financial market trends or investment techniques and strategies expressed are, unless otherwise stated, J.P. Morgan Asset Management’s own at the date of this document. They are considered to be reliable at the time of writing, may not necessarily be all inclusive and are not guaranteed as to accuracy. They may be subject to change without reference or notification to you. It should be noted that the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Changes in exchange rates may have an adverse effect on the value, price or income of the products or underlying overseas investments. Past performance and yield are not a reliable indicator of current and future results. There is no guarantee that any forecast made will come to pass. Furthermore, whilst it is the intention to achieve the investment objective of the investment products, there can be no assurance that those objectives will be met. J.P. Morgan Asset Management is the brand name for the asset management business of JPMorgan Chase & Co. and its affiliates worldwide. To the extent permitted by applicable law, we may record telephone calls and monitor electronic communications to comply with our legal and regulatory obligations and internal policies. Personal data will be collected, stored and processed by J.P. Morgan Asset Management in accordance with our EMEA Privacy Policy www.jpmorgan.com/emea-privacy-policy. Prior to any application investors are advised to take all necessary legal, regulatory and tax advice on the consequences of an investment in the products. Investment is subject to documentation, which is comprised of the Prospectus, Key Investor Information Document (KIID) and either the Supplementary Information Document (SID) or Key Features/Terms and Conditions. These documents, together with the annual report, semi-annual report and instrument of incorporation are available free of charge from JPMorgan Asset Management (UK) Limited. This communication is issued by JPMorgan Asset Management (UK) Limited, which is authorised and regulated in the UK by the Financial Conduct Authority. Registered in England No: 01161446. Registered address: 25 Bank Street, Canary Wharf, London E14 5JP.

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