Ripped From the Headlines: the Battle for GME

It’s not often that we see hedge funds getting blanket coverage over social media and mainstream media – but this week was an exception. The battle was engaged between some Goliath-sized hedge funds and a crowd of David-sized individual investors over the value and price of a little-known stock called GameStop.

GameStop is a brick-and-mortar company whose business model looked ill-prepared for the modern era of online shopping and gaming. Hedge funds such as Melvin Capital, who predicted that the company’s share price was set to fall, were caught in a classic “short squeeze” as its share price rocketed, thanks to mass investing driven by a Reddit thread. Estimates on how much was lost by institutional short-sellers come in at more than US$5 billion.

As alumni of our hedge fund program know, short-selling is one of the activities that set hedge funds apart from long-only funds and retail investors. Short-selling is restricted partly because it is an extremely risky activity, as this real-life example demonstrates. Short-sellers make money as share prices drop and lose money as share prices rise – and since ultimately, the upside of a share price is unlimited, losses can be huge. As we explain in the Henley Executive Hedge Fund Program and family office program, taking short positions relies on the services of Prime Brokers, who enable the funding and stocks borrowing that is an inherent part of the process of shorting. Even the most experienced institutions with high-grade portfolio risk management can get caught out. Portfolio risk management is also one of the topics covered in our hedge fund training.  

There are many opinions on the ethics of this situation (Ethics is another module in our hedge fund certification program), and without commenting on the rights and wrongs of various positions, some of the outstanding questions that have been raised are:

• Did anyone in the group on Reddit encouraging group action actually commit a crime?
• Did Robinhood curtail trading in GME purely because of clearinghouse requirements?
• What institutional investors benefited from the rise in price?
• When will the bubble burst and who will be hurt?
• What other stocks might be targeted in this way and why?
• What steps will the SEC take now?

We await with interest the fallout from the GME bubble and look forward to incorporating it into our real-world-based hedge fund courses as it unfolds.