A lot remains up in the air in terms of the timing and the ultimate impact of “Brexit” on the economies and markets of the UK, continental Europe and beyond. In the interim, an analysis of the open-market activity of the buy side can provide insights into how the world’s largest and most influential investors are positioning their portfolios in reaction to the surprising victory by the “Leave” camp.
Our first analysis, in what will be an ongoing series, is a review of short-selling activity prior to and immediately after the June 23rd Brexit vote in the UK. In November 2012 the EU passed a regulation that requires the public disclosure of net short positions once they surpass 0.5% of the outstanding share capital of an issuer.
The rule is not a perfect mechanism to uncover pure shorts for a couple of reasons: 1) filings are based on the net short positions of the investor not their gross short positions and 2) the filings are made at the institution/firm level, not the fund/portfolio level. Both of these facets can obscure a pure short position being held in one portfolio at a firm that in aggregate holds a larger long position. Nevertheless, by looking over an extended period, we can review the short activity that took place prior to and following the Brexit vote to determine if shorts were put on prior to the vote (as a bet that the Leave camp would prevail) or immediately following the Brexit vote (as a bet that market dislocation would continue).
Net Short Positions Reported – A Rise Since Brexit
Ipreo’s Corporate Analytics team reviewed the total number of Net Short Positions (“NSP”) reported to regulators on a monthly basis starting in January 2014 and ending in June 2016, which captures market activity following the results of the Brexit vote. Figure 1 below plots the number of NSPs in UK equities and European (ex-UK) equities filed during the time period. The number of NSPs in both UK and European equities hit peak or near peak levels in February 2016 when European markets were hit with fears of a global recession. Between February and May 2016 the number of NSPs in the UK declined 39% (from 767 to 470) and in Europe the decline was 38% (from 1,801 to 1,121). The consistent and gradual decline in NSPs in both Europe and the UK reversed course with the end of June, post-Brexit, disclosures. NSPs in the UK rose 42% (from 470 to 666) and in the rest of Europe NSPs rose a less dramatic 6% (from 1,121 to 1,192).
Average Size of NSPs – An Uptick Post-Brexit
The chart below tracks the average size, based on a percentage of shares outstanding, of the NSPs filed on UK and European equities on a monthly basis since January 2014. In June there was a slight increase in the size of the average short in both the UK and in Europe. Additionally, the average size of the NSPs in the immediate days after Brexit was at or near the monthly averages dating back to January 2014. The conviction of short sellers of UK stocks increased into early July, as the average size of UK NSPs hit an historical high of 1.82% on July 4.
NSPs Reported by Sector
In the UK, the sector with the greatest number of NSPs filed post-Brexit was Consumer Services, which saw an increase in NSPs of 80% from May to June. This rise reflects the currency impact on the pound, as well as fears of a severe economic downturn that would hurt the operations and profitability of Airlines, Hotels, Retailers, Restaurant and Bars, all of which fall into the Consumer Services sector. Other sectors that have fewer total NSPs but saw significant percentage increases in NSPs reported from May to June were Financials (+>100%) and Industrials (+26%).
In Europe the distribution of NSPs is a bit more even across sectors. NSPs filed on companies in the Financials sector led the pre-Brexit tally and increased significantly (+26%) following the vote. This increase is consistent with the outlook that many of the global banks based in Europe will be negatively impacted in the post-Brexit world. Companies in the Consumer Goods (+25%) and Industrials (+16%) sectors also saw a post-vote bump in NSPs.
Short selling is just one view of the buy side’s reaction to Brexit. Based on the initial short selling data, the buy side, like most analysts and bookmakers, did not foresee the Leave camp’s victory, as total NSPs were on a steady decline up until Brexit. The reaction by the buy side post-Brexit also seems to be in agreement with the commonly held belief that a more challenging environment is in store for consumer-related companies and financials.
Looking ahead, our next segment in the series will look at the buy-side’s post-Brexit reaction in its long portfolios.