For those that are not aware, Game Stop is a stock which had more than 100% of the free float shorted. Many well-known hedge funds had shorted the stock either as an outright trade or versus longs on their portfolios. A group of retail investors decided to organise themselves using Reddit and buy the stock forcing the shorts to get squeezed. The result was exorbitant losses for the hedge funds involved, in some cases the losses were catastrophic. On the other hand, retail investors made large percentage and some cases nominal returns.
So far nothing looks awry. However, if we look at the story more closely and the resulting actions that were taken, we should pause for thought and consider exactly what is going on as well as the implications that it may have going forward.
The first thing that is striking is that the roles of victor and vanquished are reversed in this tale. Normally it is the hedge fund that triumphs at the expense of the retail investor. Under traditional circumstance, the hedge funds celebrate their victories and shake their heads at the poor retail investor who tried to play at the big table. There are no actions taken to prevent hedge funds trafficking in the names involved and certainly no one rushes to the aid of the retail investor who may well be left without a home had they used leverage to make a bet that subsequently soured. So, I was astounded when not longer after the news of hedge fund losses came out, trading platforms started to restrict retail investors from trading in names that had been discussed on Wallstreetbets, the page on the Reddit platform where people discuss markets. Where trading could continue, margin requirements jumped to 300% in some cases. All I could ask was why?
If hedge funds that had suffered losses to other hedge funds, then most likely nothing would have happened. What seemed to irk the system is that the little guy had won. Individuals who typically have far less resources and in many cases, experience managed to find a way to make out handsomely. In a political climate where we are more divided as a society than any time that I can recall, the actions taken by brokerages post the event simply adds to fuel to the fire that the system is rigged against “the average” person. It does not make any sense to me to punish the winners of the Game Stop bet. Unless something illegal had gone on. Thus far no evidence of that seems to have come to light. Personally, I do not think that publicly disclosing the intent to buy shares in a company that has more than 100% of it’s free-float shorted in a forum constitutes any form of market manipulation. The information that this situation had arisen was there for all to see. Hedge funds get around roundtables and discuss ideas all the time away from prying eyes. This is far opaquer that the use of chat boards in this instance. Yet regulators, brokerages etc. do not react as aggressively. Why is that?
I recently completed a book called “how spies think: ten lesson in intelligence” by David Omand. One of the key takeaways from the book has been the recurring error by those in the intelligence business of not considering how information is perceived by other people. Currently there is a debate around haves and have nots and why that is so. There is an undertone to discourse which suggests that the wealth disparity has been set at the structural level. Various hindrances seem to be thrown up by the “establishment” to prevent social migration. When retail investors are made to feel like villains by being prevented from making money in a what is deemed a legitimate way, it adds credence to the view that there is in fact obstacles that prevent poorer, less resourced individuals from climbing the ladder. It makes the argument for those of us who do not believe this to be the case much weaker and thus push the fabric of society more towards political extremes.
One argument made by people who supported the brokerages increasing margins is that it prevents retail investors from suffering losses. That they do not understand risk and so should be curtailed in doing so. I have several comments to make on this. The first is who are we in the finance industry to look so disparagingly at groups of people whom we so clearly do not understand well? Given the percentage returns that some of these investors have made both in Game stop and Bitcoin amongst other investments, I do not think we can so easily dismiss their ability to take and manage risk. Secondly, whose job is it to prevent people from taking losses? If a person chooses to invest, they do so at their own risk. Countless disclaimers are found on any website offering market access that this is the case. If a person chooses to invest and then proceeds to lose his or her money, then that is something that they should be accountable for. Just as much as I am accountable in my day to day. Being responsible for your actions is something that we all should believe in.
But the market is a bubble I hear you say, and we want to stop retail guys losing their shirt when things turn. If we let them continue, then they will believe that asset prices only go up. Well, what do you think the institutional community believes to be true over the past 14 years or so? Given central banks have supported the market at every significant risk off event since the financial crisis, many a manager has made their career “buying the dip”. So, the claim that retail do not understand the market relative to institutional money holds very little weight in my view. Central banks have forced people out and down the risk spectrum looking for returns as rates have gone to 0 (and through in some cases) and QE has ramped up. Their actions have produced the financial markets that we see today, so there should be no surprises that retail investors behave as they do. In fact, many are asking why central banks bailed out banks and hedge funds in the crisis, but it was okay for their homes to be repossessed? Many trading were children during the crisis and are now able to get “back at the system”. It was their parent’s tax paying dollars that were used to bail out banks and other institutions. Consider Game stop retribution.
Retails investors are much smarter than perhaps we like to think or hope. Rather than speaking so condescendingly about them, why not share the knowledge that you as an experienced manager have to offer them. From the people that I have spoken to that trade for themselves, I find them smart and very keen to learn. If they choose to listen great, if not, then that is okay also. What we should not do is try to prevent people from trading. A new type of investor who uses social media has emerged in my view and they are just as savvy as the old guard. I think it is a very dangerous line that we walk should we choose to stop them trading rather than embracing them.
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Quay Partners Group delivers bespoke investment management solutions to independent hedge fund managers and family offices.
Supun Ekanayake, Partner, has over 15 years’ experience in trading hedge funds.