It's Not Surprising Shorts Are Hammering This ETF's Holdings

Among sector exchange traded funds, few were caught in the Brexit crossfire on par with the iShares MSCI Europe Financials ETF EUFN. EUFN is down 20.1 percent over the past month, a decline that meets the definition of a bear market.

It stands to reason. Financial services was highlighted as one of the sectors most vulnerable to Brexit and EUFN allocates 30.8 percent of its weight to U.K. banks, more than double the ETF's second-largest geographic allocation which is France at 13 percent. So it's not surprising that EUFN's holdings have been favored targets of short sellers.

'Possible Lehman Moment'

“Europe’s largest banking stocks included in the Stoxx 600 index have attracted an increasing amount of short interest in the wake of the UK’s referendum on continued membership to the European Union,” said Markit in a note. “European banks have remained under pressure since the financial crisis and have already endured Grexit fears, however the shock Brexit vote has created a possible Lehman moment for banks and short sellers alike.”

The research firm points out short sellers have added over $1 billion to bearish bets on U.K. bank stocks and two of the three most heavily shorted European banks hail from Italy, the Eurozone's third-largest economy.

Italy's Impact

Italy is EUFN's seventh-largest country weight at just over 4 percent. As non-performing loans (NPLs) creep higher, investors mulling a stake in Italy ETFs or other Italy vehicles are pondering when reforms aimed at righting the banking sector there will be implemented and how long it will take those reforms to have a noticeable, positive impact.

Italy's most recent NPL plan is not reminiscent of TARP during the financial crisis in that the country isn't looking to sell bad loans. However, complexities surrounding Italy's efforts to deal with its NPL crisis could limit participation by some of the banks residing in EUFN.

Italy's NPL problem is four times as dire as the European average. Making matters worse is that eight in 10 NPLs are corporate loans, which dampens banks' ability to increase non-financial sector loans.

“Meanwhile across European banking stocks, short interest has more than doubled year to date, with average short interest rising to 2.6% currently. The iShares Euro Stoxx Banks ETF has fallen by more than a third only just over half way through the year with the ETF is plummeting 18% since the Brexit vote,” adds Markit.