Most equity investors generate returns by buying shares of stocks they think will go up.
However, investors can benefit from stocks that they think will go down, using a technique called short selling, or ‘shorting’. To take a short position, an investor borrows the stock from a broker and then sells it at the current market price. At a later date, the investor buys the stock, or ‘covers’ the short position, ideally at a lower price, and pockets the difference. It’s buying low and selling high in the reverse order.
The ability to short stocks is the defining feature of the JPM UK Equity Plus fund. Shorting provides a differentiated source of alpha and increases the potential for the fund to outperform the FTSE All-Share index and its peers. It’s what makes it stand out in a congested peer group, where 98% of UK managers are limited to long-only strategies.
Shorting for long-term returns
Just as important is the ability to identify those stocks that are likely to perform badly. Since the launch of the fund, the identification of attractive short positions has contributed positive alpha to the JPM UK Equity Plus fund in roughly 80% of quarters.
In 2019, for example (but with no undue reliance on the past as a guide to the future), we were able to short eight out of 10 of the worst performing stocks in the FTSE All-Share and did not own the other two. This positioning contributed over 3.3% of alpha for the year. Long-only managers, in contrast, only had one way to express a negative view on these stocks—not owning them. But the extent to which long-only managers can underweight stocks is constrained by their benchmark weight. As a result, not owning these stocks last year would have generated just 34 basis points of alpha.
The near 10-fold boost in alpha shows how a manager with the ability to short, and the required skill to consistently identify the worst stocks, has the potential to materially increase returns for clients. Shorting, done well, is a differentiated source of alpha.
Shorting is sometimes considered high risk. This association may be driven by stories of racy hedge funds being caught out in short positions they cannot close, driving huge losses. However, this is more often an issue with liquidity rather than the shorting per se. There are plenty of examples on the long side where failure to manage liquidity properly has driven disastrous results for investors.
We tightly manage the liquidity of short positions in JPM UK Equity Plus. We do this by limiting each stock positions to around a day’s total average traded volume. Our investment process covers the entire universe so we can identify a range of short opportunities. Lots of positions means we can be nimble; quickly building positions where we see opportunities and not taking the risk of being stuck in positions we cannot close if they go against us.
Past performance is not a reliable indicator of current and future results.
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.