Unless you live under a rock, you probably heard about the GameStop Short Squeeze that began January 2021. Though the GameStop story is most likely over, the theme of retail investors taking on Wall Street giants is akin to David taking on Goliath.
8 Hedge Funds that Lost Money Betting Against GameStop
Although “GameStop hedge fund” is a popular Google search with—at the time of this article—more than 4,000 inquiries per month, there are no Wall Street hedge funds dedicated solely to GameStop stock. To clarify, the GameStop rally was a story that saw large hedge funds pitted against small retail investors—that is, everyday people who buy and sell stocks using trading platforms.
Reddit investors really took the spotlight in this story, as Reddit traders—that is, amateur traders active on Reddit message boards—were responsible for the market manipulation that created the GameStop frenzy. The stock rally caused many individual investors to realize that true market manipulation occurs behind the scenes, mostly to the advantage of institutional investors (banks, hedge funds, and asset management companies).
Key Takeaways
GameStop, Hedge Funds, and Short Selling: A Quick Overview
GameStop is a brick-and-mortar retailer that sells video games. The business model seems outdated to most analysts because video games can be purchased and played with streaming services, making much of the hardware obsolete. GameStop was seemingly dying a slow death, and its stock price reflected as much.
But some vocal internet pundits had other ideas, pointing to the optimistic assessment of Chewy CEO Ryan Cohen and hedge fund manager Michael Burry, who made investments in the video game company—purchasing as much as 13 percent and 3.3 percent of the company, respectively. Retail investors, especially those vocal on Reddit, began saying the GameStop stock was undervalued.
Their bullish outlook pushed the stock price up and attracted attention from institutional investors. But these institutional investors had a different idea. After performing fundamental analysis, they decided that GameStop was still dead meat, and started short selling shares of GameStop stock.
Hedge Fund Investment Strategies
A hedge fund is a company that manages assets contributed by accredited investors—that is, investors who have an income source of $200,000 more annually, and/or have more than seven figures in personal net worth, excluding their personal residence. These hedge funds are not like a mutual fund where smaller investors (such as employed individuals contributing a portion of their paycheck) place their equity into a diversified pool of stocks and bonds. Rather, hedge funds can invest however they want, leveraging strategies beyond the simple buying and selling stocks or buying and holding to collect dividends.
Some of these strategies involve using derivatives. Derivatives are not stocks and bonds, but rather contracts with a value that relates to the value of the underlying security they are tied to. One more recognizable types of derivatives is the option contract, where an investor can purchase the right (but not obligation) to buy or sell a given stock (like GME stock) at an agreed upon strike price.
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In response to these events, trading app Robinhood shut down the ability to buy shares of GameStop, triggering the ire of retail investors everywhere. It seemed that Robinhood, by cutting off the ability of everyday people to continue the short squeeze, was unfairly favoring the big banks over the little man. Robinhood was even called in to testify before Congress, where CEO Vlad Tenev defended his choice and explained that the events around GameStop had a one in 3.5 million chance of occurring.
Even still, the hedge funds that had initially bet on GameStop’s failure were now in a short squeeze, forced to sell their shares of skyrocketing GME stock to mitigate the loss.
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