In what might be the antithesis of the passive, index-based wave that has propelled the rapid growth of exchange-traded funds, the newly launched Active Alts Contrarian ETF (SQZZ) is an actively managed product that takes long positions in heavily shorted stocks.
The fund, which began trading Wednesday on the Nasdaq exchange, relies on a proprietary investment process that identifies equities believed to have a higher potential for capital appreciation resulting from a short squeeze.
Short selling is all about hoping the share price of a particular security will decrease. Short sellers take a “sell” position in a stock that a broker lends them and credits to their account. When it comes time to close the short position by buying the shares and giving them back to the lender, an investor profits if the share price fell and they buy the shares at a lower price than when they “sold” them. On the flip side, short sellers take a loss if the share price rose in value.
A heavily shorted stock can be hit by a short squeeze after unexpectedly good news—such as a surprisingly strong earnings report—causes the share price to rise and sends short sellers scrambling to cover their bets, often at a loss, which further drives share price appreciation.
The SQZZ fund’s investment process was developed by Active Alts, a Westport, Conn.-based registered investment advisor focused on bringing liquid alternative strategies to the ETF space. The company says SQZZ can potentially benefit investors two ways: From capital appreciation resulting from investing in companies with good fundamentals that nonetheless have large short positions that could be squeezed, and from lending out hard-to-borrow securities to produce income for a dividend that could boost total returns.
“The capital appreciation opportunity could be significant because I’m dealing with stocks that are heavily shorted,” says Brad Lamensdorf, founder of Active Alts and the portfolio manager of SQZZ. “You get the high power of the short squeeze at your back.”
Lamensdorf, who previously managed both short-only and long-short portfolios during prior jobs at Bass Brothers and Tarpon Capital Management, says his new ETF is the first ’40 Act fund of its kind.
The Active Alts Contrarian ETF can go 100 percent cash depending on market conditions, and it comes out of the chute on its first trading day with a cash position of nearly 82 percent of the portfolio.
“Investor sentiment just hit a 30-year high this past month; insider buying is at a 30-year low; insider selling is at a nine-year high and the price-to-sales number is 20 percent higher than it was in 2000,” Lamensdorf explains. “By any stretch of the imagination the market needs a correction, so when I see these types of conditions we’re being much more defensive in this fund than just owning passive indexes. And when the market comes back down and gives us an opportunity to get long on some of these companies where we feel the shorts are trapped, we’ll get back into the market.”
All of the SQZZ fund’s stock positions are at 1 percent to 2 percent of the portfolio, though that can go as high as 5 percent.