Ocado: Do short sellers always get it right?
29 May 2018
Short selling performs a vital function in the financial markets, according to David Lewis of FIS Global, but are they always right? He explains more
Image: Shutterstock
Timing is everything and knowledge is power. Many people’s experiences of life contain a multitude of “if only I had just…” moments. Whether those reflections are related to personal events or choices, or investment decisions, the impact is the same—a brief sojourn into the world as it would have been if only you had taken that alternative option. The internet is awash with stories of people, probably mostly fictional, who sold their Apple shares for $10, or bought apart pizza with a whole bitcoin. If only they had done the other thing, their lives would be so much better now. This week has, allegedly, seen the day that will go down as the “if only I had closed my short positions in Ocado” moment. But is that really the case, or does the answer just depend on which positions you had taken, as well as when?
A favourite investment quote was attributed to Baron Rothschild, who, in explaining the strategy behind the family’s accumulation of wealth, claimed that he “never bought at the bottom and always got out too soon.” He was referring, somewhat irreverently, to those who often claim to buy when shares are at the absolute bottom, and miraculously sell moments before the shares crash to the ground. Several articles in this week’s press have feasted on the possibility that hedge funds and short sellers in general, both terms applied to the bogey men of the investment world, may have lost their shirts as Ocado shares leapt by 45 percent on the news of what may well be a game-changing deal for the online shopping logistics technology company.
Ocado PLC, the UK-based online retailer that really considers itself a technology company, has seen its shares falter from the July 2010 initial public offering (IPO). Unable to get the shares away at the initial guide price of £2 to £2.75, the company launched at £1.80 a share. By the end of the following year, they had hit an all-time low of just £0.56, down 69 percent from the already depressed IPO. Short sellers had piled into the IPO, and, as is common with IPO stocks, the utilisation levels were kept high, even as new supply came to the market. As shown on figure one, there were high levels of variance in utilisation during the first few months following the IPO, reaching well over 90 percent at times. Those holding short positions from the IPO until the end of 2011, made a potential profit of around £1.20 a share. At the end of 2011, almost 29 million shares of Ocado, representing 69 percent of the market supply, were being borrowed.
In May 2012, as the shares were trading around the £1.20 mark, the market behaviour appeared to change, bringing utilisation and volume more into a correlated behaviour. As figure one shows, the utilisation and volume lines broadly match each other in profile from May 2012 to date. Lendable supply, for the most part, comes from the custody bank-managed investments of larger, institutional funds, those being the funds with the size to make lending their shares practical and profitable. With volume and utilisation correlated, supply must be relatively stable, suggesting that institutional investors had seen the issues facing Ocado as short-term problems, buying into the longer-term value of the proposition.
Ocado certainly spent a great deal of time promising the next big deal, even while relations with Waitrose, it’s only real client, soured somewhat and, more recently, the online giant, Amazon, muscled its way into the increasingly crowded market. Short interest waned significantly through 2013 and early 2014 as the share price advanced, peaking around £6 apiece in early 2014, with short sellers returning in the second half of that year as the price began to fall once more, down as low as £2.20 in the last quarter. Contrary to this week’s reports in the press, while some that remained in position would indeed have lost their shirts, short sellers began closing off their positions following an all-time peak volume around March 2016. Since then, borrowing volume, taken here as a proxy for short interest, has decreased by 69 percent. With utilisation standing at about 30 percent last week, as the news of the deal with the third largest retailer in the US, Kroger Company, broke, most short positions had already been closed out.
Such significant shifts in sentiment cannot be ignored as an input into investment decision-making. Certainly, there is some mileage in the story for the popular press when the short sellers make a loss, but, since the Ocado IPO, most appear to have called the price changes accurately. It is, of course, less than a year since the Carillion debacle led to what the market described as a shock profits warning, wiping billions of pounds from their share value and, in due course, leading to the failure of the construction giant. What many may not have realised was that 70 percent of the Carillion shares that were available on the market had already been borrowed, likely to support short selling positions, before the market announcement.
No investors, whether operating under a long or short strategy, get it right every time, but with a higher risk should they get it wrong, investment actions from short sellers should arguably carry more weight. Irrespective of its treatment in the press, short selling performs a vital function in the financial markets, ensuring price bubbles do not form and ensuring that inefficient companies do not absorb capital that is better employed elsewhere. Securities lending, another industry often seen as sitting alongside short sellers on the shadow banking naughty step, is also a vital component of a vibrant and efficient market place and, together, they can provide important sentiment data for investors, both long and short. Armed with that information, they just have to get their timing right
A favourite investment quote was attributed to Baron Rothschild, who, in explaining the strategy behind the family’s accumulation of wealth, claimed that he “never bought at the bottom and always got out too soon.” He was referring, somewhat irreverently, to those who often claim to buy when shares are at the absolute bottom, and miraculously sell moments before the shares crash to the ground. Several articles in this week’s press have feasted on the possibility that hedge funds and short sellers in general, both terms applied to the bogey men of the investment world, may have lost their shirts as Ocado shares leapt by 45 percent on the news of what may well be a game-changing deal for the online shopping logistics technology company.
Ocado PLC, the UK-based online retailer that really considers itself a technology company, has seen its shares falter from the July 2010 initial public offering (IPO). Unable to get the shares away at the initial guide price of £2 to £2.75, the company launched at £1.80 a share. By the end of the following year, they had hit an all-time low of just £0.56, down 69 percent from the already depressed IPO. Short sellers had piled into the IPO, and, as is common with IPO stocks, the utilisation levels were kept high, even as new supply came to the market. As shown on figure one, there were high levels of variance in utilisation during the first few months following the IPO, reaching well over 90 percent at times. Those holding short positions from the IPO until the end of 2011, made a potential profit of around £1.20 a share. At the end of 2011, almost 29 million shares of Ocado, representing 69 percent of the market supply, were being borrowed.
In May 2012, as the shares were trading around the £1.20 mark, the market behaviour appeared to change, bringing utilisation and volume more into a correlated behaviour. As figure one shows, the utilisation and volume lines broadly match each other in profile from May 2012 to date. Lendable supply, for the most part, comes from the custody bank-managed investments of larger, institutional funds, those being the funds with the size to make lending their shares practical and profitable. With volume and utilisation correlated, supply must be relatively stable, suggesting that institutional investors had seen the issues facing Ocado as short-term problems, buying into the longer-term value of the proposition.
Ocado certainly spent a great deal of time promising the next big deal, even while relations with Waitrose, it’s only real client, soured somewhat and, more recently, the online giant, Amazon, muscled its way into the increasingly crowded market. Short interest waned significantly through 2013 and early 2014 as the share price advanced, peaking around £6 apiece in early 2014, with short sellers returning in the second half of that year as the price began to fall once more, down as low as £2.20 in the last quarter. Contrary to this week’s reports in the press, while some that remained in position would indeed have lost their shirts, short sellers began closing off their positions following an all-time peak volume around March 2016. Since then, borrowing volume, taken here as a proxy for short interest, has decreased by 69 percent. With utilisation standing at about 30 percent last week, as the news of the deal with the third largest retailer in the US, Kroger Company, broke, most short positions had already been closed out.
Such significant shifts in sentiment cannot be ignored as an input into investment decision-making. Certainly, there is some mileage in the story for the popular press when the short sellers make a loss, but, since the Ocado IPO, most appear to have called the price changes accurately. It is, of course, less than a year since the Carillion debacle led to what the market described as a shock profits warning, wiping billions of pounds from their share value and, in due course, leading to the failure of the construction giant. What many may not have realised was that 70 percent of the Carillion shares that were available on the market had already been borrowed, likely to support short selling positions, before the market announcement.
No investors, whether operating under a long or short strategy, get it right every time, but with a higher risk should they get it wrong, investment actions from short sellers should arguably carry more weight. Irrespective of its treatment in the press, short selling performs a vital function in the financial markets, ensuring price bubbles do not form and ensuring that inefficient companies do not absorb capital that is better employed elsewhere. Securities lending, another industry often seen as sitting alongside short sellers on the shadow banking naughty step, is also a vital component of a vibrant and efficient market place and, together, they can provide important sentiment data for investors, both long and short. Armed with that information, they just have to get their timing right
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