### Exploiting Unusual Changes in Hedge Fund Holdings and Short Interest

**March 17, 2015** - Investing Expertise, Mutual/Hedge Funds, Short Selling

Can investors exploit the combination of unusual changes in hedge fund long positions and unusual changes in short interest for individual stocks? In the February 2015 version of their paper entitled “Arbitrage Trading: The Long and the Short of It”, Yong Chen, Zhi Da and Dayong Huang examine the power of three variables to predict stock returns:

- Abnormal hedge fund holdings (AHF), the current quarter aggregate hedge fund long positions in a stock divided by the total shares outstanding minus the average of this ratio over the four prior quarters.
- Abnormal short interest (ASR), the current quarter short interest in a stock divided by the total number of shares outstanding minus the average of this ratio over the four prior quarters.
- The difference between AHF and ASR as a measure of imbalance in hedge fund trading.

They also examine how AHFSR interacts with ten widely used stock return predictors: book-to-market ratio; gross profitability; operating profit; momentum; market capitalization; asset growth; investment growth; net stock issuance; accruals; and, net operating assets. To measure the effectiveness of each predictor, they each quarter rank stocks into fifths (quintiles) based on the predictor and then calculate the difference in average gross excess (relative to the risk-free rate) returns of extreme quintiles. Using quarterly hedge fund SEC Form 13F filings and short interest data for a broad sample of U.S. stocks (excluding small and low-priced stocks), along with data required to compute stock return predictors and risk factors for these stocks, during 1990 through 2012, *they find that:* Keep Reading