Shorter interest means longer slump - RBS 02 February 2012Sydney Reporter: Anna Reitman
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According to a recent study from RBS, increased short selling activity leads to medium term stock underperformance. The new study confirms findings from 2010 showing that when there was a 25 basis point increase in short interest as a proportion of issued capital for over one week, the stock underperformed its sector by 1.7 per cent in the following three months, on average.
Moreover, when the change in short interest is higher, 50 bps, 100 bps and 150 bps, in all of the tests, stocks underperform the market in the following three months. This suggests short sellers’ trading strategies have an element of momentum to them, notes RBS. In fact, when weekly short selling exceeded 150 bps, stocks on average underperform the market by 4.6 per cent.
Using short interest data has helped the team generate significant alpha. Since its inception in December 2010, RBS Australia's 130/30 model portfolio has an annualised 6 per cent outperformance versus the benchmark Australian capital market index.
This year, the team also included calculating short interest as a proportion of a stock’s free float as well as a days-to-cover ratio.
“A major consideration of short sellers must be liquidity/turnover and the ability to cover their shorts whilst avoiding a short squeeze. Ceteris paribus, when liquidity is lower, a higher conviction idea will be required to generate a trade due the potential of a short squeeze being higher. This is a particularly important consideration in periods of low volumes, as we are currently experiencing,” RBS analysts said.
Findings show that predictive power is boosted with these variables as well as when data is scrubbed for errors. In the Australian market, RBS estimates short seller profits of some AUD 72 billion (€58.5 bn).
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