Hedge funds have once again found themselves in their customary role as Wall Street’s biggest villains.
In a frenzied few weeks of trading, investors co-ordinating their actions on social media platform Reddit succeeded spectacularly in their aim of damaging the hedge fund of one of Wall Street’s most respected traders, Melvin’s Gabe Plotkin, a protégé of billionaire Steve Cohen. The fund lost billions of dollars on its GameStop short position and was forced to seek a bailout.
As Redditors savoured their victory, the sentiment towards hedge funds is clear. One wrote on r/WallStreetBets: “This has exposed a fraud the hedge funds have been running on the markets since before the last market crash.” Among the more printable quotes from Reddit was: “Consider it the first head on a pike for the other hedge funds to see. Always room for more if they don’t learn their lesson.”
This hostility, and particularly its vehemence, has left the hedge fund industry feeling under siege, if not totally surprised. Cohen, chief executive of Point72 Asset Management, has stopped posting on Twitter after his family received threats. “It’s pitchforks,” said one senior industry executive. However, few feel that any lessons need to be learned.
Pikes or pitchforks, it is not hard to see why hedge funds are the target: they tick all the boxes for being the bad guys, arguably even more so than bankers. They are mostly secretive, manage funds often based offshore and make big political donations. At their peak, their top performers earned more in a year than a small country’s gross domestic product. Perhaps most controversially, their best-known tool, short selling, is a means of profiting as a company collapses.
There is a sense of weary familiarity in the industry, which has had plenty of experience of being under attack. In the aftermath of the financial crisis, as tighter regulation loomed and politicians pointed the finger of blame, they desperately tried to show how they created jobs and made money for investors such as pensioners.
In 2016, senators Elizabeth Warren and Bernie Sanders co-sponsored the Brokaw Act, a failed legislative proposal that tried to curb the power of activist hedge funds it claimed were seeking “only to enrich themselves at the expense of workers, taxpayers and communities”. Brief roles as Wall Street’s good guys, for instance in The Big Short or in helping uncover the Wirecard fraud, proved to be fleeting cameos.
While many managers are keeping their heads down for fear they will end up on pikes, some in the industry are fighting back. Some are wheeling out their well-rehearsed arguments in defence of short selling, a practice shown to improve market liquidity and price discovery and help detect frauds.
“Finger wagging at short selling is not new,” said Jack Inglis, chief executive of the Alternative Investment Management Association, an industry body. “However, regardless of one’s views of hedge funds, what everybody should be focusing on is the fair, orderly and efficient functioning of markets.”
Many managers also see double standards or hypocrisy in the way investors on r/WallStreetBets co-ordinated their attack on Melvin, a move they believe would land a hedge fund trader with large fines or a prison term. “The joke is that those claiming they have ‘democratised’ finance have actually only done so by ballot fraud,” said Savvas Savouri, partner at London-based hedge fund Toscafund.
But while vocal short seller Andrew Left has decided to stop publishing short reports on stocks, the GameStop saga is unlikely to force hedge fund short-sellers to go on the run en masse.
Most managers already devote plenty of time and energy to keeping their positions secret. In Europe, many funds lurk just below the 0.5 per cent public disclosure level for short positions for as long as they possibly can, for fear of giving away information to rivals. Some do not reveal their short positions even to their own investors. Some more vocal managers may tone down their rhetoric or become less visible for a while, but short-sellers will still be there.
And rather than sympathising with Melvin, many hedge funds see its misfortune as its own fault for getting into a ridiculously crowded position and choosing a type of shorting it then had to disclose. Sympathy is in short supply. After all, hedge funds themselves are frequently the ones trying to profit from investors in the poker game of trading with the weakest hand. Whether the hit is carried out by professional or retail investors, they are realistic enough to see the GameStop saga as just another instance of how markets work.
As Daniel Yu, founder of short-seller Gotham City Research, explains: “Markets look for a vulnerable party and they go for its jugular.”