One of the hedge funds targeted by notorious Reddit investment board r/WallStreetBets is bust, the Financial Times reported on Tuesday.
The r/WallStreetBets subforum shot to fame earlier this year after its members rallied around so-called “meme stocks”—stocks facing what they considered predatory shorts by big investors—causing their prices to surge to unfathomable levels. The first and most famous target was GameStop, but other companies including AMC and Blackberry saw similar boosts. It didn’t take long for the meme stock wave to attract investors from far outside Reddit, ranging from amateur day-traders on apps like Robinhood to Wall Street sharks that saw a profitable opportunity. While Redditors liked to insist they were picking companies with strong but underacknowledged fundamentals, the whole thing was essentially speculative, and the vast majority of the meme stocks either crashed hard or remain extremely volatile and/or risky. The stock market volatility it created eventually attracted the attention of Congress, though the resulting hearing consisted of little more than shouting.
According to the FT, London-based White Square Capital took big hits during this period. A letter to investors obtained by the paper, as well as sources familiar with the fund’s operations, indicated it will soon shut down its main fund and return capital after it has completed an investigation of its business model. However, one person “close to the fund” told the FT that r/WallStreetBets and meme stocks weren’t the ultimate cause of the fund’s doomsday, as White Square made back “a fair share” of its January 2021 losses on GameStop which hit a double-digit percentage.
Florian Kronawitter, a former Paulson & Co trader and White Square’s chief, described the pending shutdown as related to a glut of greedy money in the long-short equity market. Shorting is a high-risk trading strategy where an investor (often a hedge fund) makes a bet that a company’s stock price will tank by borrowing assets and selling them with an agreement to buy them back at the market rate in the future. It was broadly despised by r/WallStreetBets, which viewed it as yet another destructive Wall Street practice that kills healthy companies and leeches profits off the overall diminishment of the economy. The meme stock rally was originally struck off by members of the board intending to pull off a short squeeze, a rapid rise in the price of a shorted stock that can force the short-seller to buy even more of it to hedge against losses, resulting in a high-stakes race to see which side goes bust first.
“The decision to close down is related to thinking the equity long-short model is challenged,” Kronawitter said, according to the FT. “...There are way too many fish in the pond with the same strategy of long-short. The traditional edge is being arbed away [eroded by other investors], there’s an oversupply of capital.”
Two major investors had withdrawn their funds from “cheap passive funds or private equity,” the fund said in the letter obtained by FT, and it chose to shut down rather than seek new sources of funding.
The FT reported that at least two other funds hit by the meme stock rally have also been stung. Melvin Capital, the original target of the GameStop short squeeze, is down 44.7% this year to the end of May, while Light Street was down roughly 20.1%.
GameStop, which peaked at around $483 per share in January before crashing, began rebounding in late February before bouncing up and down for months (with some analysts arguing it remains wildly overpriced, if impenetrable for now thanks to continued support from r/WallStreetBets). The company is pinning its hopes on a rapid pivot away from the lagging brick-and-mortar retail business into e-commerce and has hired a number of former Amazon executives to do so. Its stock price jumped on Tuesday after completing a fundraising round of $1.13 billion in capital and had gains of about 6% by midday, CNBC reported. At around 1:00 p.m., its price stood at just short of $210 a share.