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hedge funds, the stock market, and other unknowns

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A GameStop shop in Florida – it’s a US thing, but with retailers in Australia

So there’s a big story in the USA to do with hedge funds, stocks and the little guys upsetting the big guys, finance-wise, or something like that. Time for a closer look, comme on dit (I know far more about French than finance).

Having been poor (in first-world terms) all my life – and work-shy, because I’m constitutionally anti-authoritarian, and when you’re a nobody and a know-nothing, you have to work for bosses – I’ve tried to salve my guilt for living mostly off the public purse by being a more or less prolific writer and reader. Of course I’ve had brief jobs – in factories, offices, restaurants, schools, a hospital and a farm – and I did eventually manage to get to university, again off the public purse, incurring a debt I’ll never be able to repay. So during this misfit life I’ve learned a lot, in a general way, about history, politics and the various sciences, but virtually nothing about finance, the province of the wealthy.

Some preliminary remarks. Most wealthy people, surely, come from wealth. They have wealthy parents, wealthy friends and associates. They get advice from those around them about increasing their wealth, minimising losses, investment, property and so forth. I’ve heard this kind of talk at restaurant tables and in wealthy homes where I did occasional gardening work. It was like listening to people speaking a foreign language, and as psychologists tell us, we feel anxious, and sometimes hostile, when we listen to a language we don’t understand. They even have a fancy name for it – xenoglossophobia. 

The best way to overcome phobias, so I’m told, is to expose yourself, little, by little, to the fear-inducing thing. It’s never too late, so here goes. 

What is a hedge fund? The ABC (Australia) business reporter David Chau tries to explain:

Essentially, it’s a fancy word for an “alternative” investment partnership that has the freedom to invest aggressively in a broad range of financial products. They’re actively managed, and more expensive to invest in, compared to other funds. Many of them use a “2 and 20” compensation structure. It means hedge fund managers are paid a 2 per cent commission (of the assets they’re managing), and 20 per cent of profits (above a certain benchmark) each year. Even if the fund manager does nothing (or worse, loses money on your investments), they’ll still get paid their 2 per cent. Their goal is to maximise investor returns, but only “sophisticated investors” can join. To qualify, you typically need to own about $2.5 million worth of net assets, or earn $250,000 per year in gross income (for the past two financial years). So a hedge fund’s clients tend to be rich people, or big institutional investors (like an insurance company or superannuation fund).

The idea, clearly, is to invest in a company that you think will do well in the future. Or one that you want to do well, because you think what it’s doing/manufacturing etc is positive for the community, or the world. I presume, for example, that Elon Musk’s fantastical personal wealth, which he derives from his companies, is a result of people investing in those companies because they believe in what he’s doing – though that may be a naïve view. 

In any case, clearly, hedge funds are for the rich who hope to get richer. It’s like placing a bet (though presumably you can do this without joining a hedge fund), putting money into shares, calculating that you can make a profit by selling them later. This makes things a bit weird, though. You buy shares in a company because you believe it will do well, so then why would you want to sell those shares later? Presumably because you’ve lost faith in that company? Or is it just to make a profit, knowing that the shares you’re selling will be snapped up by others? But why not keep them, if the price is going up? But surely you have to sell at some time, to make a profit? To liquidate your assets? 

Okay, more questions than answers. Short selling, or shorting, as David Chau and others explain it, involves somehow borrowing shares from the market and then selling them, believing or knowing that their value will tank. After it has tanked they buy the shares again and give them back to the market at their current reduced value, and pocket the difference. Which sounds like a very dodgy practice to me, an easy or lazy way of making money – looking for businesses that are failing, which given our rapidly changing economic and technological environment, wouldn’t be difficult to find, and cashing in on the misery of those businesses. So how is this allowed, and how can you get away with selling borrowed stock? How can it be your stock to sell? I’ve watched Sal Khan, who of course I hugely admire, talking about this, but his explanations about the possible benefits of shorting seem vague to me. 

All of this attempt at understanding comes, of course, due to the ‘GameStop’ bubble which is bound to burst in the USA. Hedge funds and their rich customers have been shorting the stock of this gaming franchise called GameStop, as well as other brick-and-mortar companies that have been losing business, either due to the pandemic or to changing consumer practices. People on Reddit, a social website I’ve never used, have been doing the opposite, buying shares and doing everything to inflate the share price of these companies, and everyone’s awaiting the fallout, or the train-wreck as one pundit described it. These Reddit investors have been able to do this using an app called RobinHood, a name with obvious connotations. This has of course led to an outcry from the rich-getting-richer crowd, and the RobinHood CEO stepped in, banning the buying of these declining stocks, but not the selling. Which led to an outcry from the Reddit ‘rookie investor’ crowd, which led to RobinHood modifying its position and allowing some stock purchases. A number of financial pundits I’ve listened to, who seem largely sympathetic to the anti-hedge fund investors, are shaking their heads and predicting it will all end in tears, and not so much for the hedge fund zillionaires. Ain’t it always the way. 

Meanwhile the the wealthy professional hedge fund types are decrying the behaviour on the Reddit subgroup WallStreetBets as ‘unsophisticated’, though it’s clearly because the newbies are, quite deliberately, upsetting the applecart of making a profit from business misery. Having said that, they’re clearly trying to cash in as well. So I really don’t know quite what to make of it all. Like just about everyone else. 

Stop press (sort of): I’m not much of a gamer, so I didn’t have any idea whether GameStop had a presence here in Australia. Apparently, EB Games, which I’ve seen around, is our principal retailer for GameStop. This Crikey article, which clearly takes a much more negative line on hedge funds than Sal Kahn does, points out that EB games employs, or did before the pandemic, between 2000 and 4000 workers, and that they, like so many others, are impacted by hedge fund shorting. Here’s what the Crikey journalist, Christopher Warren, has to say:

Rather than leave matters to the actual marketplace of buyers and sellers, the masters of the universe in the financial markets decided to hurry on the collapse of retail by using “shorts”, borrowing shares to sell now, buy back (cheaper) later. The play has been hollowing out capitalism for 30-odd years in a five-step death spiral: manufactured share price collapse through shorting, which allows a cheap private equity buyout, who gut through sackings and closures, then relaunch or rebrand, before quietly closing. In journalism, movies and TV, the hedge funds are proudly the misunderstood anti-hero. Take the fictional Bobby Axelrod in Stan’s anchor program Billions: “We’re white blood cells scrubbing out bad companies, earning for our investors, preventing bubbles. A hedge fund like mine is a market regulator.” The reality is that hedge funds create no value. They’re money-sloshing machines that make money on turnover, not results. This means they’re incentivised to “do something” to maximise turnover, whether that’s moving the market through shorts, falsifying results (hello Bernie Madoff!) or offering, umm, alternative services like the late Jeffrey Epstein.

I’m inclined to take this line myself, but I’m not informed enough to be sure. And there are so many more interesting things to learn about than financial markets.

References

https://www.abc.net.au/news/2021-01-30/hedge-funds-the-gamestop-bubble-and-wall-street/13104846

Mehdi Hasan Gets a Personal Khan Academy Lesson on the GameStop Stock Squeeze | The Mehdi Hasan Show (video)

GameStop Surge Shows Power Shift On Wall Street | Stephanie Ruhle | MSNBC (video)

https://www.news.com.au/finance/money/investing/gamestop-stock-surges-again-after-trading-app-robinhood-lifts-restrictions-for-rookie-investors/news-story/76c47084a2a995e155512eec58d62d0c

 

Written by stewart henderson

February 1, 2021 at 2:59 pm