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.
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