Investors are increasingly at risk of aggressive short selling in smaller companies, according to Miton’s Gervais Williams, who has recently sold out of his “best ever investment” – the contentious Quindell.
Smaller companies have been the outright best part of the UK market over the past seven years, gaining more than double the FTSE 100. However, this year has seen a material sell-off and relative underperformance to other parts of the stock market.
According to FE Analytics, the FTSE 250 is up 0.98 per cent in 2014, having spent much of the year in negative territory, while the FTSE 100 has gained 3.17 per cent.
Performance of indices in 2014
Source: FE Analytics
The multi-cap manager, who has a particular interest in smaller companies, co-manages the £355m CF Miton UK Multi Cap Income and £150m CF Miton UK Smaller Companies funds.
While bullish on the prospects of long-term outperformance from smaller companies, he also says that the vast plunges of several high profile stocks this year suggest a connection to increasingly aggressive short selling in companies with otherwise good earnings prospects.
“There has always been a sort of ‘Evel Knievel’ reputation of people who have shorted stocks in the market, so in itself [shorting] is not new but the scale of the hatchet job reports and the level of shorting is new,” he said.
“There are a very large number of companies now under that kind of pressure. You can imagine that if you are a company dealing with another company that has seen its share price fall by a quarter or even a half, you are going to question whether or not you want to do business with that company. It is almost self-reinforcing.”
Williams says Quindell made a very high return for his fund, after he bought in at the earliest stage. But he has recently sold out completely following the worry that the stock would be subject to further falls following research firm Gotham City’s interest in the company.
Some of the biggest names in the smaller cap market such as Quindell and Blinkx saw large de-ratings following stinging critiques of their business models, by Gotham City in the case of Quindell and a Harvard professor in the case of Blinkx.
The manager said: “We did own Quindell. We were one of the first institutional investors and we had it all the way up. It made 15 times our money on our original investment and we sold at different times on the way up because it was just too big a holding.”
“We sold on the downside too. We didn’t know how far it was going to come down but it was losing momentum. It is a tragedy really because they haven't had a downgrade so it is all to do with perception.”
“Perhaps perception is reality but we just don't know at this stage. There was clearly a lot of money thrown into putting out a very one-sided viewpoint.”
The effect of short selling UK stocks has been highly debated amongst investors, fund managers and politicians, particularly this year with murky practices recently highlighted in an investigation by the Financial Times.
It found some of the worst performing stocks in the UK market had been widely shorted by anonymous shell companies belonging to a single US investment company, Tiger Global.
By using Cayman Island companies named with misleading suffixes such as GmBH to own and announce short positions in UK stocks such as Quindell, it did not break European disclosure rules.
However, several of Tiger Global’s most shorted positions have seen huge falls this year and been prolific drags on performance for several managers as well as thousands of private investors.
Critics say short selling produces greater volatility and risk in markets while cashing on challenged companies while advocates argue it increases liquidity and improves the accuracy of market information on risk assets.
Performance of stocks and index in 2014
Source: FE Analytics
ASOS was another high profile casualty, with FE Alpha Manager Harry Nimmo – who heads up the £1.1bn Standard Life UK Smaller Companies fund – partly blaming his underperformance relative to his peer group this year on the activity of hedge funds and absolute return strategies.
While once widely held as a major position across many funds, managers reduced exposure, or in case of Nimmo, sold out completely of ASOS following its plummet this year.
However, four funds have recently upped exposure. Baillie Gifford UK Equity Alpha has 3.4 per cent, Marlborough UK Multi-Cap Growth has 3.3 per cent and NFU Mutual Global Growth 1.77 per cent.
No funds hold either Quindell or Blinkx as a top 10 holding.
