Hedge funds close up shop after meme stock traders win out

A lot has been written about the rise of meme stocks and particularly those targeted by the Reddit investment board WallStreetBets.

But what happened to the hedge funds and Wall Street firms that these rebellious “stonkers” targeted – firstly with GameStop and also a range of other companies including AMC and Blackberry?

Well, the answer is nothing good, although you won’t find too many Wall Street figures trumpeting about being sucker punched by a bunch of short squeezing, pimple popping keyboard warriors.

Stonkers had better information and strength in numbers

In simple terms, the short selling institutions were taken to the cleaners by the WallStreetBets group, who correctly identified that they had overdone their “short” bets on some of these stocks and would struggle to deal with an unexpected rise in the share price.

It turns out that if you get enough people together with the unified purpose of driving up a share price, you can do it, even if individually they are all small traders.

That was particularly the case once investors outside the group, including amateur day-traders on cheap trading apps like Robinhood and even some Wall Street traders who grasped the opportunity for quick profits.

On the other side of the equation, despite plenty of bravado, the short sellers who were hoping to make a killing when the share prices in the companies dropped were bleeding cash at an incredible pace.

White Square Capital loses faith in long/short

An investigation by the Financial Times found that London-based White Square Capital took some really big hits.

A letter to investors the paper obtained, and background sources, said White Square will soon shut down its main fund and return capital after it has completed an investigation of its business model.

That is the case even though White Square managed to make good some of its January 2021 losses on GameStop which at one stage were a double-digit percentage of its assets.

Instead, White Square chief Florian Kronawitter said the pending fund closure is related more to a glut of greedy money in the long-short equity market.

Long-short funds try to outpace market gains by going “long” on stocks they think will rise at the same times as they “short” other stocks, hoping their value will fall.

Shorting might be destructive but what about a short squeeze?

WallStreetBets traders saw shorting as a destructive Wall Street hedge fund tactic that ruined good companies and grabbed unjustified profits and it turned out they were at least partly right – particularly when the shorting is overdone like it was with GameStop and grows to represent more than the number of shares that are actually available.

In a sense, though, the “short squeeze” that WallStreetBets applied to the hedge funds could also be seen as a way of grabbing unjustified profits – the only difference being that the money is coming from hedge funds rather than long term investors.

“The decision to close down is related to thinking the equity long-short model is challenged,” Kronawitter said, according to the FT.

“… There are way too many fish in the pond with the same strategy of long-short. The traditional edge is being arbed away (arbitraged or reduced by other investors), there’s an oversupply of capital.”

Big investors pull out

The letter to holders said that two major investors had withdrawn their funds from “cheap passive funds or private equity” so White Square chose to shut down rather than find new sources of funding.

The FT reported that at least two other funds hit by the meme stock rally have also been stung. Melvin Capital, the original target of the GameStop short squeeze, is down 44.7% this year to the end of May, while Light Street was down roughly 20.1%.

The battle has been pivotal for GameStop – which owns the EB Games chain in Australia – even though it has resulted in a highly volatile share price which peaked at an amazing US$483 per share in January before crashing.

GameStop raises cash while the sun shines

It has been bouncing around wildly since then with some analysts still saying it remains wildly overpriced but the bricks and mortar retail game selling business is hoping to build up its e-commerce offering and has hired some former Amazon executives to help.

It has just completed a fund raising US$1.13 billion that has been reasonably well received by the market and is now trading around US$209 a share – a far cry from the US$4.35 a share it was trading at a year ago.

Whether the WallStreetBets effect will endure or whether GameStop finally succumbs to gravity and the share price collapses, the effect of the short selling battle over the company looks set to endure.

The easy days of launching a short selling campaign and scooping up the profits seem to be over and in the enduring search for trading profits, the Wall Street hedge funds will need to look elsewhere.