Melvin Capital’s Blow Up : A Post-Mortem Analysis
Melvin Capital’s Blow Up : A Post-Mortem Analysis Melvin Capital Management LP is a US investment management company founded by Gabriel Plotkin in 2014 and headquartered in New York, USA. It mainly invests in technology and consumer stocks, and has assets under management of $24,516,798,355 according to its most recent SEC Form ADV, dated 2021-03-08.
According to the fund’s website, it adopts a “bottom-up, fundamental research-oriented process to identify investments that adopt a long-short stock strategy.” Meanwhile, CEO Gabe Plotkin described the fund as “A very labor-intensive place. We have a lot of analysts and we are very demanding of them.” He also said the fund was “very focused on the short side.”
As a result, the GameStop short squeeze incident that broke out at the beginning of this year had a significant impact on the company in addition to a series of gamma squeezes. Melvin Capital started shorting GameStop in 2014 at $40 per share.
The GameStop short squeeze event (GME event) refers to the continuous short squeeze of GameStop stocks in January 2021, which has a significant financial impact on some hedge funds. Some hedge funds were short selling GameStop, betting that the share price will continue to fall, with 140% of the total equity of the GameStop being short.
However, because the stock price of the GameStop is high and the holders are reluctant to sell, the short side cannot get enough shares to fulfill the option contract, and has to rush to make up for the position.
On the contrary, it promotes the stock price to continue to rise, resulting in the phenomenon of short rolling; Or be forced to close out due to the failure to fulfill the option contract, resulting in huge losses.
As of January 28th, the stock price of the GameStop has soared 190 times from the historical low due to the short run. On January 28, 2021, the stock price of the GameStop reached as high as $483 per share, causing huge losses to the short sellers. The event was mainly triggered by users of the r/WallStreetBetsdiscussion board on Reddit and other online trading forums through free trading apps such as Robinhood.
The incident had a major impact on hedge funds. As of January 28, hedge fund Melvin Capital, which shorted GameStop, has lost 30% of its market value in 2021. Fortress and its partners raised $2 billion in financing for Melvin Capital before the firm said on CNBC on Jan. 26 that it had closed out its entire position. Point72 Asset Management also raised $750 million in Melvin Capital, bringing the two companies’ cumulative financing to $2.75 billion.
It is also believed that Citron Research, another hedge fund that shorted GameStop, lost 100% in this event and was forced to close its positions. According to Morgan Stanley, a large number of hedge funds have covered their short positions and sold stocks to reduce leverage and market risk, the largest in the past 10 years, today it trades at $160 per share. This event inspired other companies with high short interest to be squeezed; i.e. AMC, BB & KOSS.
On January 26, 2021, it was reported that the short side lost $5.05 billion in this short squeeze. According to a survey of Ortex data, as of January 27, more than 5,000 U.S. market makers had loss-making short positions.
Melvin Capital, which suffered heavy losses in this incident, was founded in December 2014 and had assets of about US $12.5 billion at the beginning of this year. It is one of the best performing hedge funds on Wall Street in recent years. Before the GameStop frenzy, its average annual return on investment was as high as 30%.
However, such a mature Wall Street institution was crushed by the frenzy of retail shorts in January. As Reddit users attacked the heavily shorted stock, retail investors flocked to it, sending the stock up more than 1,600% at one point, and Melvin Capital, which had been betting heavily against it, lost 53% in January. At the end of January, Melvin Capital had just over $8 billion under management.
In addition to GameStop, the fund’s other short positions, such as German pharmaceutical manufacturer Evotec, battery maker Varta, and Polish video game company CD Projekt, were also hit hard by retail investors in January as their shares soared and Melvin Capital suffered heavy losses.
Meanwhile, in late January, Melvin Capital said it had closed out its short position in GameStop as the company’s share price climbed, in what was once seen as a sign of institutional “capitulation” to retail investors.
In February, however, Melvin Capital recovered some of its losses. During this period of market turmoil, Melvin’s funds received new investments, with Citadel, the world’s top financial institutions, and Steve Cohen’s Point72 fund injecting $3 billion into them.
In mid-February, Gabriel Plotkin, founder of Melvin Capital, told the Financial Services Committee of the US House of Representatives at a House hearing that the influence of social media has been brought into full play in the event of retail investors buying GameStop. For this, bears may have to change their strategy.
“I think Melvin will adapt to this change and I think the whole industry will have to adapt,” he said. Melvin’s performance may also prove that the hedge fund has adapted to the changing market environment after rapid adjustment. Melvin’s return in February was 21.7%, according to sources.
Melvin Capital’s Blow Up : A Post-Mortem Analysis Written by Xinying Lai & Edited by Jimei Shen & Jay Devon