How transparent are fund managers with short positions versus longs?
Fund managers are being encouraged to disclose more details about their portfolios in the name of transparency. However we’ve found that many managers are still very guarded when it comes to revealing their short positions, namely trades where they are betting the share price will fall.
Some fund managers are able to go long and short – i.e. they buy stocks which they believe will appreciate in value and also short-sell ones where they hope to profit from any decline in the price.
Shorting is very risky and you can lose more money than you invest. Fund managers may therefore be reluctant to disclose these positions so as not to draw attention to any trades that don’t go in their favour.
During two ‘crazy’ days in 2008 Volkswagen became the largest company in the world, at close to $400bn, as short sellers were caught out after Porsche said it would buy the rival car maker, having secretly amassed a 74.1% stake using options.
In less than 48 hours the shares jumped 4,500% to €999 per share as short sellers scrambled to buy back their positions in a very illiquid market. In other words, if a short seller had borrowed £100 of stock it would have cost £450 to buy it back just two days later.
HOW THE DISCLOSURE REGULATIONS DIFFER BETWEEN LONGS AND SHORTS
Fund managers are required to disclose their fund’s holdings above 5% of a company’s shares. However, for short positions, the threshold is 0.5% or 10 times lower, with further disclosures required at each additional 0.1% interval.
In addition, on reaching the 0.2% threshold, fund managers have to report their positions privately to the regulator, which clearly believes that short positions need to be monitored more closely than long positions.
Fund managers must have an audit every year and all portfolio holdings have to be reported, including a discussion on the changes that were made and the impact they had on performance.
BALANCING TRANSPARENCY WITH COMMERCIAL REALITIES
At the monthly reporting level, the picture is very different. Looking at some of the larger absolute return funds, some general fund manager practices stand out.
Managers tend to disclose their largest 10 long holdings but don’t do the same for short positions. Instead, they show a breakdown of shorts by sector, without disclosing the names.
However, some managers provide commentary which discusses the companies that they have shorted and the rationale for them. An example is Chris Rice who managers the TM Sanditon European Select Fund (BNY7Y72). The reader gets a description of the changes made to the portfolio and the thinking behind the decisions.
In contrast, BlackRock European Absolute Alpha Fund (B4Y62W7) doesn’t provide commentary about short positions, although in line with other groups, it does provide a break-down of exposures at the sector level.
More circumspect fund managers may not want to ‘tip the market off’ to some to their best ideas and may argue that they are protecting intellectual property by not disclosing short positions. For example, a manager may have spotted some dubious accounting or unearthed a problem with a business which has yet to come to light.
At the end of the day active fund management is a very competitive business, and good profitable ideas are hard to find.
Larger fund groups with holdings above the 5% threshold can find that they are targeted when it becomes clear that they are selling down a position or are known to be experiencing client redemptions.
This can present an opportunity for hedge funds to target the largest and most liquid holdings which might need to be sold in order to raise liquidity. They take short positions in these stocks and position themselves ahead of the fund selling down its holdings, which if successful provides a windfall gain.
After three profit warnings in as many months and a share price down 75%, Thomas Cook (TCG) issued a statement on 10 June that it was in talks with its largest shareholder, the Chinese group Fosun, regarding a bid for part of its the business. Its shares jumped 23% on the day, exacerbated by ‘short covering’, which is when investors buy back borrowed stocks to close a short position.
However, to underscore the risks with this strategy, a month later, on 12 July, Thomas Cook announced plans for £750m debt-for-equity refinancing, sending the shares down 40% to 7p.
Data from the website shorttracker.co.uk shows that the percentage of the shares registered as ‘short’ went from zero on 21 January to the current level of 10%.
TRANSPARENCY CAN BE GOOD UP TO A POINT
It is reasonable that investors demand to know which stocks a fund manager holds, if only to confirm that the stated risks are consistent with expectations.
However, it is also the case that in the ultra-competitive investment world good ideas are very valuable and some managers want to protect their own investors’ interests. Short selling has extra risks which make it harder to meet the same levels of transparency.