* Hedge funds enjoy recent success on short bets
* Long/short stock pickers thrive as rally fades
* Susquehanna increases short position on Alcatel
By Francesco Canepa and Blaise Robinson
LONDON/PARIS, June 15 (Reuters) - Hedge fund bets against selected European stocks are making a comeback, as investors pick apart a multi-year stock rally and question the market's scope to gain from the ECB's campaign to prevent deflation.
Short sellers - who borrow a security and sell it, betting they will be able to buy it back at a lower price before returning it to the lender - have in recent years burnt their fingers on the upward trajectory of European markets, helped by the ECB's pledge to keep the euro zone together.
But the bears are now wading back in, with some success: short bets on specific companies like French telecom company Alcatel Lucent or German printing machine maker Heidelberger Druckmaschinen have paid off, as markets pause for breath after hitting multi-year highs.
Overall, in April and May, Europe's most heavily shorted stocks - those with the highest proportion of shares out on loan relative to their total share count - underperformed the overall market by about 8 percent on average, according to Markit data, for the first time since the European Central Bank pledged to save the euro in 2012.
"The relief rally that lifted stocks across the board in Europe is behind us now, and stock picking is set to play a much bigger role in performance," said Bertrand Lamielle, head of asset management at B*Capital, a Paris-based brokerage and wealth management firm.
"The focus is back on relative performances, which makes fertile ground for short selling and long/short plays."
Long/short strategies allow investors to bet on the performance gap between two investments, offering an alternative to simply betting on a straight fall.
For the time being, the overall level of investors' negative bets on European shares remains muted, suggesting accommodative monetary policies from global central banks and signs of an economic recovery in the euro zone are supporting sentiment.
Last week, the ECB cut interest rates to record lows and launched measures to pump extra money into the sluggish economy.
But despite the expected positive impact for the economy, investors are betting that there remains enough divergence within individual company fortunes to be able to roll out selective short bets without worrying about another market boom.
"The environment is quite favourable for long/short strategies at the moment," said Delphine Arnaud, fund manager, hedge funds and structured products, at Lazard Freres Gestion.
"There's been a big sector rotation on the market, and typically at the end of these rotations, there are plenty of long/short ideas because there's more dispersion," she said.
Some of the most successful short trades feature negative bets on telecom gear maker Alcatel-Lucent - one of the most shorted stocks across Europe with about 12 percent of its shares out on loan, according to data from Markit.
Its stock is down 11 percent since the start of the year, while France's CAC 40 index is up 6 percent. The paper gain from combined short positions on the stock since the start of the year represents about 120 million euros ($162 million), according to Reuters calculations.
Hedge funds Susquehanna International Holdings, Aristeia Capital, CQS UK and Capstone Volatility Master are among the funds with the biggest short positions on the shares of Alcatel, tangled in an ambitious overhaul of its business.
Susquehanna has recently increased its short position on the stock, to 0.9 percent from 0.6 percent in late May, according to filings with the French market regulator. Susquehanna officials were not immediately available for comment.
Heidelberger Druckmaschinen, another of Europe's most shorted stocks with 10.4 percent shares out on loan, fell 6 percent between early April and late May.
"The fact that correlation is low and dispersion is high should tell that it's positive for long/short strategies. When correlation is low, hedge funds tend to make more money," said Antonin Jullier, global head of equity trading strategy, at Citi.
Editing by Lionel Laurent and Ruth Pitchford