There is much to be said about investing in momentum. The past few years in particular have provided investors in many UK companies with a virtuous circle of good news, share price surges, rising capital and, thus, more good news.
But when that sentiment reverses, company share prices have a habit of coming unstuck quickly. That is what has happened at semiconductor specialist IQE (IQE). Following a 379 per cent share price rise between January and November 2017, the shares have since fallen 41 per cent from their 52-week high. Sure, at 108p they are still 173 per cent higher than this time last year, but investors who only jumped on the IQE bandwagon in the past couple of months will be nursing heavy losses.
Driving the change in momentum is the growing presence of hedge funds on the shareholder register. Following the increased holding of Marshall Wace earlier in January, IQE is now the fourth most shorted company on the London Stock Exchange, with 11.8 per cent of its shares being bet against. In fact, Marshall Wace’s 4.3 per cent short position gives it the fifth biggest interest in the group.
The hedge fund is not alone in its concerns. Six other managers have short positions of more than 0.5 per cent, T Rowe Price – IQE’s single biggest shareholder – recently disposed of 5.5m shares and five more of the group’s top 10 largest investors have reduced their positions since November.
IQE develops and sells advanced wafers for use in semiconductors. For example, its vertical-cavity surface-emitting laser (VCSEL) is a crucial component in the facial recognition technology of the iPhone X. For many years, the group has enjoyed a dominant market position, which has been unassailable due to the challenges in developing competitive products. But now, the short sellers seem convinced that IQE’s market-leading position is under threat. Moreover, the group is slightly dependent on its contract with Apple (US:AAPL).
So, are the hedge funds right to be concerned, and should private investors follow their lead and get out now?
House broker Peel Hunt thinks not. In December, the broker upgraded its earnings expectations for both 2018 and 2019 by 10 per cent to take account of “an even better outlook”. In fact, all five of the brokers that regularly cover IQE suggest investors should keep buying.
Admittedly, there are some reasons to remain optimistic about the semiconductor specialist. Global customers are increasingly adopting VCSEL and this is helping to drive up both the volume and quality of revenues. Concerns about IQE’s reliance on Apple can be overstated, according to Peel Hunt analyst Andrew Shepherd-Barron. “The iPhone X contract is an easy hook to hang your hat on, but there is more to VCSELs than smartphones and more to IQE than VCSELs”. In the future, facial recognition technology is likely to be used in a range of devices and “IQE is very well placed”, he said.
But history suggests that it may be worth taking note of the hedge funds. Prior to its recent collapse, Carillion was the most shorted stock in the UK, with around 30 per cent of its register betting against it. Simon McGarry, senior equity research analyst at Canaccord Genuity Wealth Management uses the proportion of shorted shares as a useful metric when looking at potential investment opportunities. “Short selling allows hedge funds and other sophisticated market participants to generate returns based on their negative views of a stock. As a result, it provides a valuable price discovery mechanism for financial markets.”
To that end, holders of Provident Financial (PFG) and Debenhams (DEB) – which top the depressing roster of Britain’s most shorted companies – have reason to be wary. Investors in both have had to stomach major profit warnings in the past few months and, if the short sellers are proved correct, their woes may not yet be behind them.
