Short Selling Research
France has joined the UK, Australia and Japanese markets in enforcing public disclosure of short positions above certain thresholds. The EU is considering making this mandatory across all of Europe. While some investors will dislike this disclosure, others will look for ways to make use of it. Today I’ll summarize some new research from Texas University, Deutsche Bank and Oliver Wyman. For more insight, please visit the new Research and Academic section of our website: www.dataexplorers.com/research.
Oliver Wyman reports on a number of downsides that are predicted by the fund management community from public short selling disclosures and makes recommendations for politicians drafting the current regulations. Stock market professionals often understand the purpose of shorting better than politicians. Yet, the proposed regulation for the disclosure of short positions will not address the market imbalances that allowed LVMH to build a stake of over 15% in Hermes in total secrecy.
That aside, on the premise that markets are efficient and that short positions are worth watching, there is some interesting research which assesses how professional investors can apply this information. Some investors have incorporated short selling signals into their stock screening for years due to an intuitive feeling that people who bear the risk and cost of shorting must do so with strong conviction. This is borne out by the latest academic research from Edward Swanson of the Mays Business School at Texas A&M. He proves that investors can make money doing the opposite of what the sell side analysts recommend, if they are suggesting investors “buy” in names where short selling is very high. “Essentially, the short sellers are doing a tremendous job of using information with predictive value, and they really look like value investors."
Deutsche Bank’s Quant group in January published an exhaustive piece of research to address this exact issue on the US market. In “The Long and the Short of it” the Quants come up with a bespoke factor after back testing the Data Explorers securities lending database, field by field. Lucky them. This led to three sample portfolios of Long/Overweight, Underweight and Short names to illustrate what their factor was suggesting people trade. Of most importance is that their factor stands up to practical implementation since they found ways to avoid stocks that are expensive to borrow, and as a result those most prone to short squeezes. Most prior back tests on public short selling data do not account for this. For aficionados, there is lots of information on how the signal, is somewhat regime specific, its correlation with other factors, and works well even if you only do monthly turnover.
Contrary to what one might expect, “The Long and the Short of it” is also helpful for Long Only managers who can “generate significant alpha by underweighting hard to borrow stocks”. Long Only managers used to complain about short selling but the research shows ways that they make money from it, without bearing the costs of shorting.
Banning short selling during the financial crisis has merely served to increase the appetite for people to understand it better. The proposed public disclosure requirements add fuel to this debate. The new research section of our website includes the detailed short selling papers created by academics, banks and consultants. We hope it will create greater clarity around this often misunderstood topic which will be covered in detail at the Securities Financing Forum in London on 16 March. For more information please visit www.dataexplorers.com/london.
