Golden Eggs

Written by Jennifer Hill

February, 2021

In association with

Profiting from the dirty dozen

JPM UK Equity Plus differentiates itself from its peer group through the ability to short. Fund manager Callum Abbot said “We use shorting as a way to get meaningful underweights in a market with a structure that restricts long only managers from doing so.”

A dozen stocks that the JPM UK Equity Plus fund has shorted since its inception in 2015 have plummeted by 90% or more.

‘There are stocks out there that fall a lot – and some that go to zero. We have a decent success rate in identifying them,’ said Callum Abbot, one of its four managers.

Their ability to short stocks they expect to underperform the market sets the fund apart in a crowded UK All Companies peer group, where 98% of managers are limited to long-only strategies.

Described by JPMorgan as an ‘active extension’ fund and more commonly known as a 130/30 fund, the strategy typically takes 30% of its gross market exposure through short positions. The capital freed up is reinvested to increase long positions in stocks deemed to have outperformance potential to 130%.

Investors have 100% net exposure to the market but can benefit from negative as well as positive sentiment. In the fund’s first five years and four months (from September 2015 to the end of 2020), the managers added 1% p.a. of alpha through shorts.

Stock market darlings

The 12 shorted stocks that have lost at least nine-tenths of their value are a mixed bag but there are some common themes.

Two are former stock market darlings – challenger bank Metro Bank and UAE hospital operator NMC Health.‘They looked really expensive to us, with an unbelievable amount of [investor] expectation attached to them,’ said Abbot. ‘Metro Bank was very painful for a while – it kept going up but people came to realise it wasn’t going to hit anywhere near its growth targets.’

NMC was propelled into the FTSE 100 amid an increasingly insured Middle Eastern population demanding better healthcare provision, but Abbot and his co-managers were conscious of slowing growth and concerned about how senior managers were remunerated – on EBITDA rather a per share metric or cash generation.

‘We were worried about the quality of their capital allocation. They were buying businesses to hit their targets rather than focusing on return on capital,’ said Abbot. ‘It unravelled very quickly after Muddy Waters [the activist US hedge fund] revealed a bet against the stock and accused it of understating how much debt they had.’

JPM UK Equity Plus fund shorted NMC in the summer of 2018. Muddy Waters cast ‘serious doubts’ on the company’s financial statements, including its asset values, cash balance, reported profits and reported debt levels, in December 2019, and the JPM managers closed their position shortly afterwards (see chart).

‘When it gets near the bottom, we tend to cover our position because it can get quite volatile,’ said Abbot. ‘Some companies can sort themselves out and bounce back quickly so from a risk control perspective it’s sensible to close out.’

Modern trends

Three are retail related. Ted Baker, Mothercare and Britain’s biggest shopping centre owner Intu Properties ran into trouble before the coronavirus pandemic shut down the high street.

Intu owns Lakeside in Essex and Trafford Centre in Manchester and was once a constituent of the FTSE 100. However, Covid-19 exacerbated a ‘nasty mix’ of heavy indebtedness, plummeting retail property values and aggressive rent re-negotiations by tenants. Intu went into administration last summer, the outcome for shareholders almost certainly being zero.

Mothercare collapsed prior to the pandemic in November 2019, its sales of baby and children’s equipment and clothing having been cannibalised by e-tail giants like Amazon and competitors that have better capitalised on online demand like Next – one of the fund’s established long positions.

Ted Baker, meanwhile, has failed to adapt to the vogue for casual dressing and been unsettled by a string of director departures, including its founder amid allegations of impropriety in March 2019.

‘Clothing retail is a difficult market, especially if you fail to keep up with modern trends – Arcadia is the latest casualty of that,’ said Abbot.

He also blames fierce competition for the downfall of contracting companies Capita and Kier Group. ‘Most contractors favour cost-plus contracts but they got stuck in fixed price contracts that turned out to be more expensive that they expected.

‘Construction is a very competitive and low margin business. When you’ve got lots of competition it can be a winner’s curse.’

Another two are commodities businesses – Petra Diamonds and Nostrum Oil & Gas. The former had struggled due to indebtedness and the declining diamond price, while the latter has hit several dry or uneconomic wells.

Investment Case: An owner and operator of hospitals, primarily in the Middle East that was for many years considered an exciting growth story.
We took a short position as the valuation did not reflect slowing growth and poor cash generation and that management incentives were poorly aligned with shareholders. Concern built through 2019 that the company’s accounts had issues, this culminated in a short report from Muddy Waters alleging fraud.
The company went into administration in April 2020. Source: J.P. Morgan Asset Management using data from Bloomberg. Data from 9th September 2015 to 26th February 2020 when the shares were suspended.

About the author

You may also like…

J. P. Morgan managers capitalise on smaller company activity

J. P. Morgan managers capitalise on smaller company activity

A pick-up in share placings, IPO activity and beaten-up companies moving down the market capitalisation scale has the managers of JPMorgan UK Smaller Companies spoilt for choice. Georgina Brittain and Katen Patel have invested selectively with a focus on capturing the...

The long and short of it: Review of the markets in March

The long and short of it: Review of the markets in March

The UK continues to track along the government’s road map to opening up. All the statistics are moving in the right direction and the vaccination effort has been exceptional. The government has promised a review of their guidance to work from home before stage four...

Domestic smaller companies poised to lead UK recovery

Domestic smaller companies poised to lead UK recovery

A host of UK smaller companies have reported results ahead of analysts’ expectations in what JPMorgan fund manager Katen Patel deems to be the start of a strong re-rating for domestic earners. ‘The Covid-19 crisis hit UK company earnings hard last year – mid and small...

In association with