It’s not just because it’s mid-August that shorts are all the rage. Grabbing the headlines at present is Elon Musk, the sometimes over-emotional and certainly far from shy chief executive and founder at Tesla.
Perhaps unsurprisingly given the high-profile of Musk himself and the still arguably nascent car business he fronts, Tesla is the most shorted stock in the US right now. Such is Musk’s ire at this that last week he resorted to bragging via his Twitter feed about a potential $72bn buyout of his company by the Saudi Arabian state investment fund in an attempt to roust the shorts out of their positions.
It failed, of course, not least because he appeared to be very much jumping the gun when it came to his claim that he had “funding secured”, a claim now being investigated by the Securities and Exchange Commission (SEC).
The net result of such a high-profile gambit has been to focus attention on why Tesla is being shorted in the first place. A note this week from the research team at MSCI makes an interesting comparison between the California-based electric car manufacturer and others on the most-shorted lists.
The research team highlight what they suggest are a number of common characteristics. Among these are earnings variability, liquidity (you have to have the shares available to short), residual volatility and beta factors. The shorted stocks were negatively corelated with momentum, size, earnings yield and investment quality.
As the MSCI team suggested, “in other words, stocks favoured by short sellers tend to have unpredictable earnings, volatile share price, high trading liquidity, rapidly growing assets and expensive valuations.”
The other obvious correlation is between sentiment towards the stock, i.e. a rising share price, and the short interest. This much would seem obvious even to Musk himself who clearly believes that setting the rabbit running about a buyout is the way to flush out the shorts.
A more interesting idea though was put forward by another team at MSCI last November and that suggested that short interest could be a factor. In its findings, the paper (published last year on ETF Stream – link to: http://www.etfstream.com/investor-focus/research-library/2080_is-there-a-short-interest-factor) suggests that short interest is a “robust factor that provides unique explanatory power in the cross section of stock returns beyond what is explained by other well-known factors.”
They added that short sellers are “informationally advantaged” who via their actions reveal a “valuable aggregate sentiment” that both complements and adds to other factors. Moreover, they suggested that short interest had demonstrated a strong and consistent performance across all major markets for over 10 years.
It will be interesting to see whether any smart beta fund providers take up the challenge of introducing short interest into one of their multi-factor funds.
But of course, taking advantage of the potential to short a stock isn’t a one-way street. ETFs are also a product that themselves can be shorted. Nothing unusual in that. They are after all an exchange-traded product and as such it is entirely possible to take a view against any given ETF for a multiplicity of reasons, including hedging or managing risk.
But the newsflow in the past week or so with regard it the tumbling Turkish lira and the apparently deteriorating fundamentals within the country has led to the reappearance of a lesser-known shorting phenomenon.
This is the create-to-lend process whereby an ETF provider can create new ETF shares in any given fund in order to give them to the short seller.
Such would appear to be the case in relation to the iShares MSCI Turkey ETF where, as was noted by Bank of America’s weekly colour update on securities lending, an additional 1.5 million shares went out on loan this week. In total, it means that 4 million shares in this ETF are now out on loan.
“I wonder if these are to go short rather than to go long,” said Peter Sleep who added that such a process would be cheaper than shorting Turkish listed entities via the futures market.
It may appear murky but create-to-lend does have a history. A research paper from 2014 issued on the Eurex website points to an instance when during the financial crisis, the US financial authorities instituted a short selling ban on the banks. ETFs were exempted from the ban but even there liquidity was limited.
Analysis of the S&P 500 SPY ETF before, during and after the ban showed that immediately after the ban announcement, short interest in the SPY began increasing. At one point, the research shows, close to $5bn new short sale positions were created using the Spider ETF.
“Driven by rapid share creation, market capitalization of the SPY grew during the ban – arguably to fill the corresponding rise in short selling demand… This demonstrates how shares were essentially created for the sole purpose of short selling. This case study demonstrates how the create-to-lend mechanism in ETFs facilitated the short selling during the U.S. financial ban. This was obviously neither anticipated nor welcomed by the regulators.”
Whether the new instance of create-to-lend would arouse anyone’s ire other than perhaps the even-more-emotional-than-Musk President Erdogan in Turkey is hard to guess at. However, more examples of create-to-lend during future instances of market stress might be more controversial. This is one to watch.