An Index that excludes stocks that are expensive to short

[FLBiker]

Some referred to this article in the thread about WSB and GME, and a paragraph caught my eye.

Article: https://yudkowsky.medium.com/r-wallstreetbets-is-trying-something-unprecedented-in-history-and-the-medias-not-reporting-it-7ab507e4a038

Incidentally, I’ve read a paper claiming that an investor can get 5% higher returns than the broader market shows on paper, simply by indexing broader stocks except for stocks that cost a lot to short. This doesn’t violate the (weak form of the) efficient markets hypothesis — because what’s actually going on, is that big holders of stocks are collecting interest from loaning out the stocks themselves, instead of their brokers doing it behind the scenes; and this payment factors into the efficient stock price.

Does anyone have any more information on this?  I'd like to see a link to the original paper, and I'd love to learn about an index fund that does just this.  Or is it something I'd have to create myself (in which case I'd love some info on exactly how to do this)?

[MustacheAndaHalf]

I found this research paper on "short interest" as an investment factor.  Momentum is slightly negatively correlated - stocks moving higher the fastest tend to have less short interest, which makes sense.
https://www.msci.com/documents/10199/4585b0fa-8415-4fb2-ad25-b21b11c06910

As the least shorted investment... the S&P 500?   SPDR S&P 500 (SPY) is apparently at decade lows in short interest.  Having the 5 biggest stocks gain +50%, and then adding Tesla, probably triggered that.
https://www.bloomberg.com/news/articles/2021-01-14/short-interest-in-world-s-biggest-etf-plunges-to-decade-lows

[FLBiker]

Thanks for that link to the paper.  And it's good to learn that the S&P 500 already effectively does this.

[ChpBstrd]

Thanks for the excellent brain food posted earlier.

To answer the OP’s question Google and I were unable to find any funds that exclude highly shorted stocks as one of their main strategies. I’m sure some active managers are doing this behind the scenes but they aren’t advertising it.

I do know that a portfolio of 40-50 stocks will closely approximate their indices. If the short interest factor is as big as the MSCI paper suggests, then stock-picking the lowest SI stocks in the S&P500 would be expected to outperform the index despite the reduced diversification. Doing pairs trades (e.g. bullish and bearish spreads) on the top and bottom deciles would also be expected to outperform, unless SI is somehow factored into options prices. Of course that strategy is getting murdered at this unique moment.

[FLBiker]

Thanks for the additional comments.  Ultimately, the conclusion I'm coming to is that attempting to do my own index is more trouble than it's worth.  I'll stick with what I've been doing.  Thanks!