The importance of checking and rechecking your work while having the patience to see your investment thesis through are some of the lessons that Jupiter’s James Clunie has learnt over his career of short-selling. 
Clunie is head of strategy, absolute return at Jupiter Asset Management and specialises in single-stock short-selling. While there are many styles that short-sellers can use, Clunie – who runs the £1.5bn Jupiter Absolute Return fund – focuses on stocks that appear overvalued under most scenarios and that have a clear catalyst for a potential market derating, such as a poor earnings result or signals from short-selling data.
The manager’s personal rules for short-selling include acting with patience, waiting for catalysts, taking incremental rather than dramatic position sizes, measuring new information against old, being willing to act flexibly not habitually, and learning from mistakes.
Performance of fund vs sector and index under Clunie
Source: FE Analytics
Below, the Jupiter Absolute Return manager uses four case studies to highlight the most important short-selling lessons he has learnt over his career.
SunEdison
The first example that Clunie gives is renewable energy company SunEdison, which had excited the market thanks to its “propensity for financial innovation and aggressive, debt-fueled growth”.
“As has often been the case with these sorts of ‘glamour’ growth shares, hubristic management strategies were initially mistaken for acumen,” the manager said. “Stock valuations soon lost touch with sensible measures of value and growth. Often, the denouement arrived when a company’s high growth strategy turned out to be its nemesis.”
Clunie added that this seemed to be case with SunEdison as it had created a complicated way of transferring assets and cash flows between it and its subsidiaries. Clunie started shorting the company in September 2014 at $20.74 but this ended up being “a painful and somewhat perplexing experience”.
While Jupiter Absolute Return’s team thought the company was fragile, this view was not shared by the rest of the market and SunEdison’s shares climbed to $32. However, Clunie uses an information-based stop losses – where a change in the information against the rationale for shorting the stock typically leads to a position being cut – and, as this information had not changed, the fund continued to hold onto the short.
Over the summer of 2015 SunEdison’s shares started to fall and the fund ended the trade at $8.65; Jupiter Absolute Return ended up making “a good profit” on the trade, albeit in a volatile fashion. The company filed for bankruptcy in April 2016 under the weight of its highly complex financing structure and opaque business model.
Explaining the lesson from this short, Clunie said: “When going against the crowd there can be great pressure to accept the status quo even when a critical analysis would suggest that something was amiss, and to adopt the view that the dominant narrative probably does seem somewhat plausible. This is one of several reasons why we check and recheck our work throughout the life of a position.”
Glencore
Clunie’s favourite ever short position was in Glencore in 2015. Like SunEdison, the commodity producer and marketer’s rapid growth was based on debt and financial innovation.
Performance of stock between July 2014 and end of 2015
Source: FE Analytics
“We did the usual homework with this stock,” the manager explained, “conducting an initial quantitative screen which we followed with fundamental analysis: reading the report and accounts, and undertaking reverse-discounted cash flow analysis to assess what expectations were priced into the stock. We looked into the ecology of the stock, who owned it, who was short and what they were doing at the margin.”
This research concluded that Glencore had fewer options than major peers such as Rio Tinto and BHP Billiton, while another red flag came from the fact the firm’s directors were selling shares. Jupiter Absolute Return started shorting Glencore in July 2014 at 377p but the shorting path “was not entirely smooth” as the company published decent trading statement in February 2015.
But its results statement in August 2015 was “terrible” and this ultimately led to a share price collapse. Glencore fell sharply and in a panicking market and the Jupiter fund was able to achieve some good prices when covering the stock; its final exit price was 79p in September 2015.
And the lesson? “In the best cases, being a contrarian has its benefits in terms of trading costs,” Clunie said. “In the case of Glencore, going against the prevailing market mood meant we were able to provide liquidity and cover the short position, placing bids below the market.”
Tesla
Clunie argued that Tesla “looks like the perfect short on paper” for reasons such as being rated poorly on a number of quantitative screens, only having two profitable quarters since listing in 2010, missing production targets and burning through piles of cash. This has resulted in the electric car company becoming a “crowded” short.
“Yet, these warning signs haven’t diminished the market’s enthusiasm for the stock. Tesla’s market value has come to rival that of car companies like Ford and General Motors,” the manager said. “The stock has been driven higher by excitement about its innovative products and powerful storytelling by Elon Musk, the company’s charismatic CEO.”
The battle between Musk’s “devotees” and the short-sellers has been fierce over the years, especially in 2017 when Tesla’s stock price hit an all-time high as Musk whipped up enthusiasm about the forthcoming Model 3 Tesla car and taunted short-sellers on Twitter.
During this time, there was evidence of short-covering – or short-sellers buying back the stock to trim or close their shorts – and this can exacerbate the potential overpricing of stocks when exuberance abounds.
Jupiter Absolute Return has a short in Tesla, even though Clunie tends to dislike being in an overcrowded shorts. One reason for this is that other short-sellers covering their positions can work against his own.
“I’m willing to short some stocks like Tesla, however, which are crowded and risky because I feel strongly about these companies fundamentally. But I need strong conviction to be in situations like those,” he added.
“Taking part in an overcrowded short boils down to odds versus information, and conviction on that information. Given part of our job is to mitigate downside risk, we have to be acutely aware of the risks in cases like Tesla.”
McDonald’s
Fast food franchise McDonald’s might not seem like an obvious candidate for shorting, according to Clunie, but Jupiter Absolute Return has held a short position in McDonald’s for some time, “largely because of the expectations embedded in the company’s share price”.
Several quality stocks like McDonald’s have seen their share prices climb to what the manager considers to be “unsustainable levels” because of the heavy demand for so-called bond proxies and buying linked to the rapid growth in exchange-traded funds (ETFs).
At the same time, the current market price of McDonald’s assumes that its earnings margin will climb to 65 per cent over the coming six or seven years. Given that analysts expect this margin to rise to just above 40 per cent this year, Clunie said achieving the 65 per cent seems “highly unlikely”.
The manager conceded that there is nothing fundamentally wrong with the company but his short is based on the view that there seems to be some misplaced confidence in the ability of the stock to maintain a high valuation in the face of adversity. While he’s not expecting McDonald’s to fall dramatically, he believes current high valuations appear unsustainable; for this reason, the fund is also shorting Campbell Soup, Nestle and Danone.
Explaining the lesson, he said: “A good company may not be a good stock to own. They are not immune to periods of investor overconfidence or technical factors like the excess demand from exchange-traded funds. Nevertheless, for short-sellers, waiting for this pricing anomaly to correct can require patience.”