Heavily shorted shares have underperformed the rest of the universe in Europe for the second month running in May. We review the shares currently targeted by short sellers.

• The most expensive European shorts have underperformed by 1.2% in May
• Scandinavian airlines SAS has passed fellow peer NAS as the more shorted of the two
• The most expensive European shorts have underperformed by nearly 2% this year

The fee charged in order to short a specific security incorporates multiple sentiment indicators that may be considered esoteric to non-securities lending market participants.

It includes both the demand to borrow as well as the availability. This single number represents, as an annual percentage, what investors are willing to pay in order to gain short exposure to a security. It is fair to say the most expensive stocks to borrow are often those with the most negative sentiment. This was reviewed in our recent review of the performance of the most expensive shorts in North America and Asia over the last few months.

Today’s focus on Europe finds that the most expensive shorts in Europe have also underperformed over the last couple of years, although the signal is not nearly as strong or consistent in this region compared to the rest of the world.

Expensive to short shares underperform-but not consistently

The top 10% most expensive shares to short in the Markit Developed Europe universe have underperformed the market by a cumulative 8% in the 24 months leading to the end of May.

But this underperformance could be misleading as most of the underperformance occurred in the first three months of the observation period. The subsequent 18 months have proved to be inconclusive for European short sellers, as the most shorted shares alternated between outperforming and underperforming the market. This inconsistent performance of the most shorted shares in Europe makes a stark contrast to the consistency seen in the cost to borrow Asian and North American shares.

The last couple of months have brought some respite for European short sellers however as the most shorted shares underperformed the market in successive months for the first time since summer 2012. The 0.6% and 1.2% underperformances recorded in April and March respectively have ensured that the most expensive European shorts have underperformed the rest of the market by nearly 2% since the start of the year.

Banks among the most shorted

Currently among the shares commanding a high fee and a strong utilisation are four banks, making banking the best represented sector within the 10% most expensive group with a utilisation rate above 50%. These companies are all peripheral names which are currently in the process of recapitalising after the recent Eurozone crisis.

Of those four firms, Italian bank Banca de Monte Dei Paschi has the largest proportion of its shares outstanding out on loan with 10.8%. The firm is going through a €5b rights issue, so it’s safe to assume much of the current demand to borrow is driven by desire to play the rights issue as opposed to directional short selling.

Also seeing high demand to borrow in this space are National Bank of Greece and Liberbank which are also busy raising capital from shareholders.

Airline wars

Transportation firms also see high demand to borrow with three firms among the shares seeing high utilisation. An ongoing directional story is in the airline space with Scandinavian airlines SAS and NAS currently battling for top regional spot in the region.

While NAS was seen as the hot short a year ago, the attrition tide seems to have turned in its favour after it was able to beat analyst expectations over the last couple of quarters. These developments have seen shots cover a quarter of their positions since the start of the year.

SAS is currently seen as the potential loser by short sellers in the duel between the two firms after it has seen short interest double since the start of the year. While the firm has a lower proportion of its shares out on loan, the shorts are currently paying more to borrow SAS shares than NAS ones, showing a greater commitment in the short.

Methodology

We compared the performance of 10% most heavily borrowed stocks against the broader Markit Developed Europe Universe, using Markit’s Implied Loan Rate factor. This is based on the Markit Securities Finance indicative loan fee which measures the cost charged to hedge funds to sell a share short.