What You’ve Missed in European Short Markets Recently
Using daily filings from the European Short Disclosure Regulation, Novus tracks nearly 50 billion euros in short investments across 250+ managers.
Halfway through 2019, markets continue to remain unpredictable and uncertain, with a fantastic first quarter being followed by a catastrophic performance in May and a remarkable turnaround in June. Volatility such as this is a great opportunity to reflect on one of the fundamental characteristics that define hedge funds: the ability to short. This post dives into the daily filings of over 250 managers, as required by the European Short Disclosure Regulation, and analyzes how an aggregate portfolio of these filings has performed in the first half of 2019.
European Short Activity Increases
Despite markets performing well, we saw the number of shorts increase in 2019 along with the AUM of the aggregate portfolio, proxied here by the total market value of the underlying positions. This is a reversal of the trend of declining short positions we saw last year. Extending the time horizon reveals that this is part of a larger trend, where managers tend to increase the number of positions in their short book after difficult quarters, such as Q4 2018.
Figure 1: Assets under management (blue) and number of positions (red) in H1 2019
Figure 2: Positions have risen substantially over the last 6+ years, spiking after market downturns
Are Investors Seeing Returns from Shorts?
The portfolio YTD is down 6% but outperformed the market in May, generating a 9% return, while the S&P 500 was down over 6%. This trend is common for a short-only portfolio which typically outperforms the benchmarks when markets are down. Figure 3 illustrates this well, charting the portfolio returns against the S&P 500 and MSCI Europe for 2018 and 2019.
Figure 3: Aggregate portfolio returns vs benchmarks
We see a clear correlation between market performance and portfolio returns, with the portfolio’s largest upswings occurring in Q4 2018, and a similarly impressive performance this May.
As a side note, we recently covered how a manager’s top conviction shorts consistently generate alpha compared to the rest of the portfolio.
France, UK, and Real Estate Become (Un-)Popular Picks
Slicing by sector shows us that in the past six months, aggregate short exposure to Real Estate and Communication Services has increased significantly, while exposure to Energy and Utilities have fallen.
Figure 4: Short sector exposure delta, as a percent
The increase in real estate exposure is interesting given the market chatter regarding sub-sectors. German bank Commerzbank stated in early June that housing prices have been rising rapidly in the majority of eurozone economies, with many analysts and experts fearing that a real estate bubble is likely in Europe. Alternatively, declining housing prices in the UK could also be a factor, as reported by the Telegraph in June.
Breaking it down by region reveals that the portfolio exposure to the United Kingdom increased significantly in 2018, primarily compensating for reduced exposure to Germany, Sweden, and Italy. This trend appears to have held so far this year, with the UK accounting for 40% of the book as of June.
Figure 5: Geography exposure 2018-19; only showing countries with exposures >1.9%
While several factors could be at play here, Brexit drama is obviously one of them—most recently with the postponement of the initial “divorce date” of March 29, 2019, and Theresa May’s resignation. With experts speculating on the outcomes of Brexit for nearly three years now, it is not outlandish to assume that hedge funds are betting against UK stocks in anticipation of further Brexit uncertainty.
The Best Shorts of 2019
Despite markets performing as well as they did all year, the potential to find pockets of alpha on the short side remained. Below are the names that have the lowest returns so far in H1 2019 of all stocks reported to the European Short Disclosure Regulation, making them the biggest wins on the short side year to date.
Figure 6: Top 10 shorts of H1 2019
It’s worth noticing that the top performing shorts are not the most popular shorts. For one, the sector shift discussed earlier aren’t reflected in the distribution of top names, which are spread pretty sparsely across multiple sectors from Healthcare to Industrials. In the table below, we’ve assigned each position a crowdedness score between 0 to 1, 1 being the most crowded based on our proprietary methodology, in order to present which names were the most popular among managers shorting in Europe.
Figure 7: Top 10 most crowded shorts, and respective performance
The lack of overlap between the top performing shorts and the most crowded ones is actually positive from a risk perspective. It reduces the danger of what is known as a short squeeze, a situation in which a heavily shorted name moves higher, forcing short sellers to close out their positions and consequently adding upward pressure to the stock.
Thriving markets seemingly failed to diminish hedge funds’ penchants for shorting in the first half of 2019. We’ll keep watching to see if the second half of the year continues to be driven by individual names scattered across various categories, or if more specific sectors/regional trends emerge, as we’ve seen in past years.
Novus clients have access to daily insights from the European Short Disclosure Regulation (ESMA): category-level exposures, the largest short positions in our aggregated portfolio, the best shorts each month, a ranking by short interest, and a list of new short positions.