When a stock attracts more large short sellers, an activist hedge fund’s campaign has a higher chance of success.
Additionally, the likelihood of activist success is even higher when investors are in disagreement. Short sellers and activists tend to “agree to disagree by targeting the same company” and disagreement often stems from differences of opinion and the presence of “unsophisticated” or inexperienced investors.
Those are the key takeaways from a study by researchers at the University of Florida, the University of Cambridge, and Columbia University.
“It really depends on the point of view,” said researcher Pedro Saffi of the University of Cambridge in a phone call. “Activists look at the glass half full and short sellers…half empty.”
Researchers also found that activist investors are more likely to start new campaigns in companies that have already attracted the interest of large short sellers. However, activist investor presence in a stock has no impact on large shorts’ attraction to that company, which researchers attribute to a potentially “heightened short-squeeze risk.”
“Often, it’s much more difficult to be a short seller than an activist” Saffi said. “The typical position of a hedge fund activist tends to be larger than the larger short sellers. Often, activists create a kind of coalition, called wolfpacks, to try to implement changes with management.”
Saffi, along with researchers Tao Li and Daheng Yang, created a sample of 648 activist campaigns in Europe between January 2010 and December 2019. The researchers then merged this sample with data on 14,646 large short positions from third-party data provider Activist Insight.
Saffi, Li, and Yang looked at what happens when stocks targeted by large short sellers are also targeted by activist investors. The researchers found that companies with more short selling tend to earn higher returns than those with no large shorts. Researchers also tested various pairings, concluding that activist campaigns tend to be more profitable if there is a large short seller in place.
The researchers also hypothesized that “corporate managers are more likely to accept activists’ demands and implement their proposals” if large short sellers are present. Consistent with this hypothesis, researchers found that “the cumulative abnormal returns are higher for stocks with at least one large short seller (6.13 percent) than for those without a large short position (4.06 percent).”
“If you’re the management of a company, you’re more willing to play ball with the activists, because, if you don’t, the large short sellers might carry on with the narrative and prices will go down,” Saffi said.
The research arises during a period of relative transparency in the European Union. In 2012, the EU streamlined short-sale disclosure regulations, requiring investors who reach 0.2 percent of the issued share capital to report their positions to the relevant authorities, according to the European Securities and Markets Authorities website.
“In Europe, we know the identity of the large short sellers,” Saffi said. “We then use this to see what happens when these big investors get together.”
Because of this increased transparency, activist investors are able to track and follow the movements of large short sellers.