September 19, 2008 / 3:31 PM / 10 years ago

Hedge funds seen switching short exposure to retail

LONDON, Sept 19 (Reuters) - Hedge funds are likely to increase short exposure to retail stocks following a ban on short selling financial shares imposed by UK and U.S. regulators, industry insiders said on Friday.

Equity long/short and market neutral hedge funds will be among those most affected by the ban as short selling — betting the price of a share will fall — is a key component of their investment strategies.

Shorting financial stocks has been a popular trade among hedge funds this year, but now they will be forced to switch their attention to other sectors.

John Godden, of hedge fund consultant IGS Group, said: “Commodity and infrastructure providers are continuing to be strong and showing signs of growth going forward. Some service industries are likely to be pretty heavily hit by a slowdown so from a market neutral perspective, there’s your long and short sectors.”

“You’re going to see shorting occurring where there’s pressure on volumes and margins in the service industries such as retail,” Godden said.

Mehraj Mattoo, global head of alternative investments at Commerzbank, added, “If the Wall Street problem begins to translate into the Main Street problem, then clearly some of the retailers and the builders will be affected so there are plenty of other sectors where hedge funds could be taking short positions.”

On Thursday, the UK Financial Services Authority banned short selling of financial stocks until January. It said it could extend the ban to other sectors.

Short selling has been blamed by many for exacerbating recent market volatility and in some corners for the slump in the share price of HBOS HBOS.L which led to Lloyds TSB (LLOY.L) stepping in with a deal to rescue the lender.

The retail sector is already the most shorted sector. Research firm dataexplorers.com data shows that at Tuesday’s close retail stocks had an average of 8.2 percent of their shares in issue on loan, a reliable indicator of the amount of short selling on a company.

Bank banks were only the fifth most shorted sector, with 5.9 percent of their shares on loan on average.

Among retail stocks, the most shorted company was HMV HMV.L, which had almost 37 percent of its stock on loan at close of business on Tuesday.

PRIME BROKERAGES HIT

The banning of short positions on banks, aimed at supporting share prices amid market turmoil, could dent the profits of some of the firms it aims to help — those with prime brokerage units who provide services to the hedge funds.

Andrew Shrimpton, a partner with hedge fund consultants Kinetic Partners and a former head of the hedge fund unit at the Financial Services Authority, said, “It is going impact the profitability of prime brokers ... There is no question of that.”

“The ban on short selling (financial stocks) will mean some hedge funds will not be able to execute strategies they want to do,” Shrimpton said. “For prime brokers this will reduce revenues. It will have a negative impact.”

In recent years, prime brokerage has been one of the fastest growing profit centres for investment banks. The gains are a result of hedge fund industry assets under management expanding to over $2 trillion — double the level of four years ago.

The exact financial impact on prime brokerage is hard to estimate since banks do not break out data on the business. Morgan Stanley (MS.N) and Goldman Sachs (GS.N), which have a combined market share of around 60 percent in prime brokerage according to industry estimates, are expected to be the worst hit. (Editing by Joel Dimmock and Quentin Bryar)

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