Obtain the data you need to make the most informed decisions by accessing our extensive portfolio of information, analytics, and expertise. Sign in to the product or service center of your choice.
Highest borrow fee US equities outperformed by 29% MTD
More to short interest data than meets the eye
The January 2021 short squeeze may go down as the most
significant ever, given the soaring share prices of highly shorted
US equities. The performance of short interest factors - that is
methods of ranking stocks by most to least shorted with the aim of
going long the least-shorted and short the most-shorted - are on
pace to suffer their worst month on record in January. The most
heavily shorted firms, per the exchange short interest,
outperformed the least shorted by 23.9% MTD through January 28th.
The nearest competition for "worst month for short factors"
consists of April 2009 when the most shorted outperformed +15%, and
April 2020 (most shorted outperformed by +21%), per the IHS
Markit Research Signals database. Ranking by the percentage of
shares on loan yields a similar result for January, with
most-borrowed outperforming by 23.6% MTD. Even more stark is
ranking by borrow cost, where the most expensive to borrow US
equities outperformed the least expensive to borrow by 29% MTD,
also a record. It's worth bearing in mind the breadth of these
results: Even if the heralds of the short squeeze, GameStop and
AMC, were removed from the analysis, the relative outperformance of
high-fee US equities would still be more than 25% for MTD January
as compared with the lowest-fee shares.
Background:
From March 2008 through March 2020 the most expensive to borrow
US equities (high-fee) underperformed the least expensive to borrow
shares (low-fee) by an average of 1.3% per month. This has been
observed in academic
research as one of the most consistent quantitative investment
factors in terms of raw price returns. Given the historical
underperformance of high borrow fee shares, simply filtering out
high-fee shares as potential long positions has been popular with
some long-only active quant funds, which has had a consistently
positive impact on returns since the GFC (not taking into account
the foregone opportunity to lend those shares to capture the
elevated fees). There have been some prior periods with relative
outperformance of high-fee shares, specifically late-2013 to
early-2014 and the 2nd half of 2016, however those periods were
relatively brief, and the rolling 12-month average return spread
was never positive for more than three months. For an active
manager those periods would have introduced underperformance, for
example avoiding highly shorted biotech companies in 2013 and 2014
would have resulted in lagging behind benchmark indices which had
exposure. In that case, the relative underperformance of crowded
biotech shorts over the 2nd half of 2015 and first half of 2016
would have suggested the avoidance of high-fee shares had been
efficacious. Similarly avoiding highly shorted energy companies
over the latter ¾ of 2016 would have caused a manager to lag an
index with exposure, however the valuations in that cohort, largely
shale-related producers, were already far below where they'd been a
year prior and continued to fall thereafter. Those experiences may
have suggested that high-fee shares were likely to underperform in
the medium-to-long run, and that countertrends were likely to be
short and were furthermore unlikely to undo more than a year's
worth of underperformance before returning to the long-run
trend.
Following the substantial outperformance of high-fee shares in
April and June 2020, the rolling 12m average spread between high
and low fee shares turned positive and has remained there since.
Including the MTD return through January 28th, the highest fee US
equities have outperformed by 2.6% per month on average over the 12
months. While these shares make up a relatively small amount of
most benchmark indices, the marked outperformance relative to
low-fee shares may be driving relative underperformance for
long-only managers who don't own them (to say nothing of the
comparison to funds who also lend the shares for an additional
return). This may set up an additional buyer of highly shorted
shares - long-only investors who were previously underweight. Of
course, the opposite side of the trade is a portrait of pain for
short sellers, who are currently paying an average 11% annualized
borrow fee for the most expensive to borrow shares, in addition to
losses incurred by the increasing share prices. The lessons learned
on the short side in 2013/4 and 2016 appeared to manifest in the
market declines at the end of 2018 and in March 2020 where there
was a muted reaction on the part of short sellers to the broad
market decline. That was a far cry from Q1 2016, when short
positioning increased dramatically in share terms amid the market
decline, to the chagrin of the short sellers shortly
thereafter.
The surge in prices for highly shorted US equities in the early
going of 2021 was partly set up by the 2020 year-end positioning,
which saw an all-time record for debit balances in margin accounts
and short interest value. The December 2020 margin statistics from
FINRA shows a record for debit balances in margin accounts,
$778bn. The December 31st short interest observation set a record
with $915bn in short positions reported (subsequently dethroned by
Jan 15th observation at $946bn). It's interesting to contrast these
balances with year-end 2019, when short interest positions were
valued at $860bn (then a record) while debit balances were $579bn
(-13% compared with May 2018 record).
GameStop:
The poster child for the 2021 short squeeze is undoubtedly
GameStop (GME). While the trading dynamics of the GME trade extend
well beyond short positions in the common shares, a few points are
worth considering on that front. Firstly, in terms of timing of
information, there was a 5.6m share reduction in shares on loan
tied to settling Jan 13th trading, which reflected some amount of
short covering, but that the short position in share terms had only
declined slightly in reaction to the single day 57% increase in the
share price. The Jan 15 short interest data was published on Jan 27
and showed that the short interest had only declined by 9.4m shares
as of mid-Jan, confirming the signal suggested by the share
borrowing data, that the majority of the short position remained in
place as of Jan 15th. The number of shares on loan declined by
another 19m shares from Jan 22 - 28, suggesting that a larger
portion of the short position was covered amid the surging share
price during that week. It is worth pointing out that the total
short interest (or shares on loan) were only a tiny fraction of the
traded volume during this time, which does not preclude short
covering from having had an impact at specific points in time, but
the buying of shares to cover shorts can only go so far in
explaining the increased share price.
There has been substantial discussion of the GME short interest
as a percentage of shares outstanding or float. On this topic it's
worth remembering that shares are not consumed in the short selling
process, they are sold onward to a new holder who then faces the
decision to lend or not. If every holder were willing to lend 100%
of their holdings, and no holders were restricted from trading or
lending, then the only limit would be that the short interest
couldn't increase by more than the total shares
outstanding each day. It is important to realize that there is not
a logical inconsistency in more than 100% of shares outstanding
being short. As an example, imagine there is an investor who owns
100% of the outstanding shares of a firm and a short seller who
every day borrows 100 shares and short sells them back to the long
investor. Eventually the short seller will be short 100% of the
shares outstanding, at which point the long investor will be long
200%. On that day the long investor would have custody of 100% of
the shares and could lend some or all of them to the short seller
again. In practice, many investors only make a portion of their
holdings available, some don't lend at all and others own shares in
margin accounts (where they may be lent depending on the usage of
margin debt), so there are fewer than 100% of shares to start with
and the purchaser of shares from a short seller may not lend them,
both of which result in an uncertain supply of shares for short
sellers to borrow. The supply of shares from beneficial owners in
securities lending programs can be tracked as a real-time
indication of availability from institutional owners of shares,
while the gap between the exchange short interest and borrowed
shares provides an indication of shares sourced by broker dealers
away from the traditional securities finance channel.
AMC Holdings:
AMC Holdings serves as a reminder that short interest may be
more than it seems. Firms in the movie theatre business have been
popular shorts since the pre-COVID era and AMC was among the most
heavily shorted firms in terms of both borrowing of the firm's
bonds and equity at the start of 2020 (bond borrowing substantially
unwound during March and April) . While a contingent of directional
equity short sellers likely remains in the trade, a portion of the
recent AMC short position is likely related to hedging the firm's
outstanding convertible debt, which was converted on January 27th.
The process of hedging a long position in a
convertible bond, when the common share price is increasing,
involves shorting an increasing number of shares as the delta of
the embedded call option approaches one. In practice, that will
look like short sellers "fighting the tape" by shorting more shares
as the price increases; taking full account of the trade, the price
of the convertible bond may be increasing by more than the
delta-adjusted hedge, delivering a profit to the arbitrageur. While
there is not evidence regarding short positioning specific to the
holder of the AMC convertible note, the tightening of the borrow on
September 14th, after a reset provision was triggered for the
outstanding convertible bond, which increased the number of shares
each bond was convertible into, suggests convertible hedging was a
meaningful factor for short positioning in the shares, as noted in
our
Q3 snapshot. The impact of convertible hedging may have
recently increased amid the surge higher in share price, which
would help to explain the increase in share borrowing despite what
would appear to be a face-melting short squeeze.
3D Systems:
Sometimes a short squeeze can be fairly identified as such
nearly in real-time, in the sense that a large decrease in total
short positioning coincides with a substantial increase in share
price. 3D Systems (DDD) is exemplary, with the shares on loan
falling dramatically on the settlement date following the share
price doubling on January 7th. The number of shares on loan
declined by 14.8m shares, which may have had a material impact on
the share price doubling, but it certainly was not the only
contributor with more 197m shares of traded volume that day. The
DDD share price has increased by another 65% since January 7th,
with only a 5m share reduction in borrowing, suggesting that short
covering has had rather minimal impact on the trend higher after
the initial squeeze.
Conclusion:
When will the bad times end for short sellers? Has the short
interest factor return inverted? These questions could have been
asked at any point since last April, with no more certain of an
answer on offer then as now. This moment is historically remarkable
and, like so many financial time series, the returns for heavily
shorted US equities will likely be measured against the last
12months for some time to come.
Stay tuned for securities finance and short selling commentary
from IHS Markit Securities Finance!
Posted 29 January 2021 by Sam Pierson, Director of Securities Finance, S&P Global Market Intelligence
IHS Markit provides industry-leading data, software and technology platforms and managed services to tackle some of the most difficult challenges in financial markets. We help our customers better understand complicated markets, reduce risk, operate more efficiently and comply with financial regulation.