Apparently, a call-to-arms has rung out across Hedgistan during the past few months – get shorting. Earlier this month Merrill Lynch observed in a client letter that S&P 500 futures had rarely been shorted this much before. And yesterday, Pensions & Investments ran an interesting story that indicates it’s not just the S&P futures that are experiencing uncommonly high short interests.
According to Bloomberg, short positions in NYSE-listed names now equal 3.3% of overall market cap – the highest it’s been since records began in 1995. At the same time, a team within Merrill that keeps an eye on this type of thing said that “speculative investors” had $45 billion in S&P short positions by July 3 (the highest amount in 3 years). While not an all-time high, Merrill described this as “crowded” and suggested it was a positive indicator for stocks.
Naturally, we were curious about the role, if any, of emerging strategies such as 130/30 and portable alpha. Far from being a bearish bet on stocks, short positions in these strategies are part of everyday business. Sure, one could argue that the very adoption of these low beta strategies indicates an investor’s view of market beta. But this is a significantly weaker form of market timing than that which Merrill describes as “speculative”.
The experts we consulted generally said that portable alpha and 1X0/X0 weren’t yet big enough to have a significant impact on the S&P futures market. Instead, most said this was simply an indication of a growing bet against equity markets.
But with seemingly every asset manager on the planet either starting or looking into a 130/30 strategy, we wondered whether this secular shift in strategy could someday overshadow regular cyclical shifts in market sentiment.
Monday’s story in P&I discusses this very possibility:
“Along with hedge funds and 130/30 strategies, growth in the market value of assets…are seen by custodians and pension fund officials as reasons for increased demand.”
“The impact of new 130/30 strategies has not been fully felt yet, but is expected to boost securities lending revenues significantly in the future. ‘This is a small component but a growing component,’ said State Street’s Mr. (Craig) Starble (head of securities finance).
“Mr. Starble estimated pension funds will put $500 billion in 130/30 strategies over the next few years, which would mean a lot more demand for securities to borrow. ‘These are not dollars taken away from a hedge fund or other strategies. These are from traditional long only-managers.'”
P&I points out that 1X0/X0 may be a wash for institutional investors. While income from lending out their securities has increased 20% in the past year, these so-called “short extension” strategies generally charge higher fees. (We have seen examples of fees based on gross exposure, so a 130/30 fund would cost 160% of the long-only fee for that asset class). In an odd bit of circular calculation, P&I even cited experts who said funds could even just borrow stock from themselves.
Other sources of demand for short positions come neither from secular shifts in asset management, nor speculative market bets. P&I cites merger arbitrage as being a non-directional (albeit cyclical) driver of demand for short positions. With mega-mergers being announced almost daily, demand to short the acquirers has also stoked the shorting fire.
If Merrill is right and “crowded” shorts are bullish for stocks, the call-to-arms may subside for a while. But regular readers of this website will probably agree that short-selling is likely in a secular bull market.