29-04-2022 · Insight

Quant chart: Meme stock frenzy confirms short-selling signal

After more than a year following the short squeeze in so-called meme stocks, the informational advantage of short-selling data resurfaces.

    Authors

  • Matthias Hanauer - Researcher

    Matthias Hanauer

    Researcher

It is well documented that short-selling information has predictive power for future stock returns that goes beyond established factors such as low-risk, momentum, quality and value.1 However, the risk of short selling (for example, in the form of a short squeeze) and high lending fees have cast doubt on the risk-adjusted net profitability of shorting individual stocks.

That said, short-selling information can also be used in long-only applications by either (i) investing in the least shorted stocks, (ii) underweighting the most shorted stocks, or (iii) discriminating between similarly attractive low-risk, momentum, quality or value stocks.

In January 2021, however, the Reddit-fueled retail trading frenzy in highly-shorted ‘meme stocks’ such as GameStop and AMC Entertainment Holdings2 called into question the validity of the informational advantage gained from short-selling data. So did these events of January 2021 constitute a short-term phenomenon, or did they mark the end of an investment signal that had been successful for a long time?

Figure 1 | Cumulative relative performance for stocks sorted on short-selling information

Figure 1 | Cumulative relative performance for stocks sorted on short-selling information

Source: Refinitiv, Markit, Robeco. The figure shows the cumulative returns of stock quintile portfolios based on a composite of short-selling information. The quintile portfolios are equal-weighted and the outperformance is measured against the equally-weighted universe. The investment universe consists of MSCI Developed Index constituents. Region and sector neutrality are applied by independently ranking stocks within each region/GICS level 1 industry (11 sectors) bucket. Developed market regions are North America, Europe, and the Pacific. The sample period is January 2020 to March 2022.

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Figure 1 shows the cumulative outperformance of stocks sorted into five quintile portfolios based on a composite of short-selling signals. These signals include the shorting ratio, but also take into account several criteria such as demand, supply, fees and liquidity.

In January 2021, the most shorted stocks outperformed by about 3%. However, after that, they underperformed leading to a cumulative underperformance of about -10% over the sample period. By contrast, the least shorted stocks only marginally underperformed in January 2021, before rebounding and generating an outperformance of around 8% over the same period. These results, therefore, suggest that short-selling data still offers investors valuable information beyond common factors.

Important information

The contents of this document have not been reviewed by the Securities and Futures Commission ("SFC") in Hong Kong. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice. This document has been distributed by Robeco Hong Kong Limited (‘Robeco’). Robeco is regulated by the SFC in Hong Kong. This document has been prepared on a confidential basis solely for the recipient and is for information purposes only. Any reproduction or distribution of this documentation, in whole or in part, or the disclosure of its contents, without the prior written consent of Robeco, is prohibited. By accepting this documentation, the recipient agrees to the foregoing This document is intended to provide the reader with information on Robeco’s specific capabilities, but does not constitute a recommendation to buy or sell certain securities or investment products. Investment decisions should only be based on the relevant prospectus and on thorough financial, fiscal and legal advice. Please refer to the relevant offering documents for details including the risk factors before making any investment decisions. The contents of this document are based upon sources of information believed to be reliable. This document is not intended for distribution to or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation. Investment Involves risks. Historical returns are provided for illustrative purposes only and do not necessarily reflect Robeco’s expectations for the future. The value of your investments may fluctuate. Past performance is no indication of current or future performance.