Retail day traders on an internet message board, Reddit, banded together to push up the price of GameStop (GME) and other stocks. GME started the year at $17.25, it closed January 27th at a price of $347.51 and reached an intraday high of $513.12. The subreddit is filled with posts, such as this, of traders making millions on this stock. GME was one of the most shorted stocks in the market. This huge runup in price has meant that several hedge funds have suffered heavy losses. Some hedge funds have even needed to raise money in order to stay in business. For example, Melvin Capital, a fund with $12 billion under management, needed an injection of $2.75 billion after losing over 30%.
The details on how small retail traders were able to increase prices to a level that brought several hedge funds to their knees can be found here. What is interesting about the GME story is that it is purely about market supply and demand, not fundamentals. GameStop is pretty much the same company it was 3 weeks ago, yet it’s price has increased over 20 times. This is purely driven by the mechanics of how option trading and hedging works, the huge amount of short interest, and increases in volume in the stock. In fact, other heavily shorted stocks such as Nokia, BlackBerry, Koss Corp have seen huge increases in price because of the same dynamics. As we write this, brokers are limiting customers from buying these stocks in hopes of quelling the madness. Surely regulations and/or lawsuits will follow. This is a great reminder that some times liquidity trumps fundamentals.
Following the last article’s theme, several brokerage firms prevented retail traders from buying more shares in Gamestop and other stocks which were being heavily traded. Their initial reasoning was that it was done to protect the individual investor. After these restrictions, speculation emerged that hedge funds had pressured these brokerages to limit trading in order to prevent their increasing losses (which would be highly illegal). After heavy backlash from their users, traders, and even some politicians, they changed their story. Now they say that it was because of their “financial requirements” and “capital obligations”. Robinhood, a retail broker, drew down its line of credit and raised $1 billion from their existing investors. Every time a broker executes a transaction, they need to post a small fraction of the trade’s value as margin. Since trading volume in these stocks went through the roof and the stocks became extremely volatile, the brokers needed to post ever increasing amounts of margin. Therefore, they limited trading in order to shore up their finances.
The article then talks about another short squeeze in the 1920s. Obviously what is going on today is very different than in the 1920s. There was no Reddit, no Twitter, no free trading, no internet, etc. However, the basic concepts and mechanics of a short squeeze are pretty much the same. There have been other examples of massive short squeezes, such as Volkswagenin 2008, when it briefly became the world’s most valuable company.
Placement agents help private equity fund managers with fund raising, fee structures, governance, clawback provisions, and in creating narratives for the general partner to market the fund. They act as facilitators for investor meetings and communication with investors and provide assistance with due diligence. This article examines which funds tend to use placement agents, and they document a substantial negative correlation between investing with placement agents and subsequent returns. In other words, “the higher frequency with which an [investor] invests in funds affiliated with a given placement agent, the worse the returns are for that [investor].”
The authors look at a variety of fund types and find that funds which use placement agents significantly underperform funds which do not use placement agents. It might simply be that the best funds do not need placement agents in order to raise money. Private equity has a lot of issues: high investment concentration,high fees, low diversification potential, returns comparable with public marketswith increased risk, and aflawed way of measuring returns(IRR). The use of placement agents further adds to this list. As you may have noticed we are not big fans of private equity funds.
The quantitative asset management firm, AQR, has reduced their outlook for every asset class. Their forecast for real returns on US stocks is a meager 3.8% per year for the next 10 years. US treasuries sit at -0.5% and US cash at -1.5%. Their forecast for a globally diversified 60/40 portfolio has come down to 2.1%.
With bond yields near all time lows and stocks at historically high valuations, returns going forward will be depressed. We have been hammering on this drum for some time. We cannot expect returns going forward to match those of the past. Conditions today are very different than they were 30 years ago. Faced with lower returns going forward it is crucial to focus on keeping costs low, diversifying, and managing tax burdens properly.
Bonds backed by aircraft leases have seen large increases in demand in recent weeks. Many airlines do not purchase aircraft outright, instead they lease the aircraft from companies such as Castlelake LP. These companies many times offload their risk via bonds to other investors. These bonds are backed by the aircraft and the yield is generated by the lease payments airlines make to use the airplanes. Recent transactions have been oversubscribed because investors are clamoring for yield.
Related to the above article, as yields have fallen in recent years, investors have moved up the risk curve in search for yield. Aircraft-lease bonds are volatile and risky, especially in the midst of a pandemic where the airline industry has been hard hit. During March of 2020 aircraft backed bonds fell to around 70 cents on the dollar as airline prices plummeted. We have seen a trend of investors moving into riskier asset classes looking for yield without understanding the risks involved.
