Questcor Pharmaceuticals Inc (QCOR), J.C. Penney Company, Inc. (JCP): Hedge Funds, Not So Good At Shorting, Great At Picking Small Caps

So far this year, the 30 most widely shorted stocks from the beginning of 2013- as measured by the number of shares short as a percentage of the float- have returned 34%, outperforming the S&P 500 by a considerable margin. While in our analysis these stocks do have an average beta a bit higher than 1- about 1.2, judging from daily returns this year- this isn’t high enough to account for their superior returns. In other words, so far this year heavily shorted stocks have, on average been good sources of alpha.

Take Questcor Pharmaceuticals Inc (NASDAQ:QCOR), for instance. Short sellers had sold nearly half of the stock’s float at the beginning of this year, placing the provider of drugs treating multiple sclerosis and other conditions near the top of “most popular shorts” lists. Yet the stock was up over 90% even before a pop in July after adjusted earnings per share came in well above consensus forecasts. Another example would be SUPERVALU INC. (NYSE:SVU), an owner of grocery store chains which had been heavily shorted at the beginning of this year on the basis of its poor performance. Supervalu has beaten expectations and is now up over 180% year to date.

PERSHING SQUAREShort sellers have had successes- including J.C. Penney Company, Inc. (NYSE:JCP), where billionaire activist investor Bill Ackman of Pershing Square (see Ackman’s stock picks) has failed to turn around the company- but on average, this has been a bad year for short targets as these stocks have tended to not only go up but to outperform the bull market. We can generally assume that much of the short interest in these heavily shorted stocks belongs to hedge funds using them to hedge their long portfolio. Of course, we know that some particularly high profile hedge fund shorts have surged this year as well: Ackman’s own short target, Herbalife Ltd. (NYSE:HLF), has roughly doubled. Billionaire David Einhorn of Greenlight Capital (find Einhorn’s favorite stocks) reiterated his recommendation of Green Mountain Coffee Roasters Inc. (NASDAQ:GMCR) as a short last fall, and it’s nearly doubled year to date as well (the stock is still down form when Einhorn initially recommended shorting).