Robinhood shows social media should be feared by both the bad and good
- The GameStop short selling saga showed the power of social media in organising a ragtag group to take on Wall Street hedge funds.
- It might seem a triumph for both merry men and the common man, but this power poses a danger beyond the finance industry, writes Neil Newman
LITTLE JOHN WAS A BIT ON THE SHORT SIDE
Before 2021, Robin Hood was a 15th century heroic English outlaw who was “feared by the bad, loved by the good”, wore green tights and shot arrows into bad guys along with his sidekick “Little John”. Hundreds of years later, Robinhood is the slayer of hedge fund managers who sell short the good guys.
Investing in a business with no growth, or potential of a turnaround, is something we try to avoid. But there is a group of investors that make it their business to do this – and it can be very profitable. They bet on failing businesses by “going short”.
When you as an investor decide to change your mind and sell your investment on, it is an easy task if your shares are traded on a stock exchange, which introduces buyers to sellers and provides a record of who owns what.
So, here I am, and I would like to sell you my shares and you would like to buy them. We “discover” the price on the stock exchange and we do the deal, typically settling up a few days later.
A short sale is no different, except that as the short seller, the shares that I sell to you, the investor, were borrowed from someone else on a promise that, at some point, I would return the same amount of shares to them. I reckon there’s a good chance that the business you now hold shares in will fail, and that I can buy those shares back from you a lot cheaper than I sold them for.
Whether I’m right or you’re right, one of us will make money and the other will suffer a painful loss. Although short sellers profiting from a company going down seems rotten, it is a helpful tool to remove market risk on a position, or “hedging one’s bets” – hence “hedge funds”.
KEEPING YOUR ARROWS SHARP
Forum users online discovered through crowdsourced public information that hedge funds were profiteering from the misery being inflicted by Covid-19 on bricks-and-mortar retailers, in the first instance on GameStop Corp shares (GME: US). GameStop store sales fell 31 per cent in the first nine months of 2020 due to Covid-19, and the stock was heavily shorted. The merry men of Robinhood decided to come to the rescue and started to buy the stock.
Shares in GameStop were driven from US$18 before the coordinated action began, to a record high of US$483 – which threatened to wipe out the hedge fund Melvin Capital, which had to be bailed out by two others to the tune of US$2.75 billion. Severe pain was inflicted on numerous other funds who had copycat trades on the books.
ROBIN HOOD, ROBIN HOOD, RIDING THROUGH THE GLEN
Following this ride to GameStop’s rescue, Robinhood’s band of merry men moved on to some 20 other stocks.
US securities market regulators are looking into the trading frenzy to determine if it is illegal. Schemes to manipulate markets generally are, but it would be difficult to pin this on individual traders. Even as the saga unfolds, it seems perhaps the damage has been done, and we can draw a few conclusions at this point.
•Hedge funds and Wall Street continue to be broadly disliked by everyone who is not working in the financial industry. The introduction of low-fee exchange traded funds (ETFs) that sidestep the hedge fund club and are traded on inexpensive platforms could soon finish them off anyway;
•A company’s fundamentals suddenly matter a lot less than the behaviour of a crowd of investors. Would you short Robinhood shares on day one if you believed it was a fad? Ordinarily, probably yes; now, definitely no.
Short-selling is nothing new, it was invented in the very early 17th century, and by mid-1772 had precipitated its first major financial casualty – the collapse of nearly every private bank in Scotland and a huge liquidity crisis in the major banking centres of London and Amsterdam over excessive negative speculation in the shares of the East India Company. The activity today remains a thorn in the side of market regulators.
To suggest that this could be the beginning of the end of short-selling is perhaps a bit extreme, but fund managers will have to think about short positions much more carefully, even considering the potential of public opinion. Melvin Capital certainly did not consider offending the gaming community or the nostalgic general public who still use bricks-and-mortar stores when shorting a gaming stock.
Neil Newman is a thematic portfolio strategist focused on pan-Asian equity markets