- An army of small investors has bloodied large hedge funds on Wall Street.
- It looks like Steinhoff short-sellers could also be targeted.
- But there are probably too little shorting and too few small retail investors to stoke a local war.
- For more articles, go to www.BusinessInsider.co.za.
Following the jaw-dropping events on Wall Street this week, where a large army of small investors banded together to wreak havoc on large hedge funds, short-sellers in South Africa could be forgiven for a degree of nervousness.
The six millions people who are part of the WallStreetBets investment discussion group on Reddit have piled into shares of GameStop. GameStop owns shops that sell video game discs and memorabilia, and its business has been taking strain as gamers switch to online buying.
Large hedge funds have been betting GameStop's share price would fall, by engaging in short selling.
It’s a way of making money from shares that fall. Short sellers borrow shares from shareholders in the company – with a contract to replace the same number of shares to the owners at a later date. They then sell these shares, betting they can buy the shares back later at a much lower price.
For example, they sold 1,000 shares for R10 each, pocketing R10,000, with an agreement to replace the borrowed shares in a month’s time. When they have to replace the shares, the company is now trading at R8 – so they only need to pay R8,000. Profit: R2,000, minus a fee for the “borrowing” contract, and trading costs.
But short-selling can also turn against you. If the share price rose to R12, you would now have to fork out an additional R2,000.
The funds ended up holding large short positions in GameStop's shares - which is precisely why the Reddit community chose to buy GameStop shares.
They knew that if they chase the price higher, these professional investors – who they blame for manipulating the market for decades and profiting when others lose money - will bleed billions.
And so it transpired. They triggered a mass feeding frenzy in GameStop shares, with the share price up 1,700% since the start of the year. This meant calamity for the short sellers in the company, who now had to buy these very expensive shares to settle their positions. This is called a “short squeeze” and has cost these funds R290 billion.
“This is Joe Citizen getting back at Wall Street,” says Wayne McCurrie, portfolio manager at FNB Wealth and Investments. McCurrie expects that small investors will soon target another GameStop-like company. “And then another. And then another. But fingers will get burnt.”
Companies like Nokia and Blackberry have already grabbed the attention of these small armies of investors, who are hoping to stick it to hedge funds by driving prices higher.
Locally, Steinhoff seems to be a contender. Already this week, the share saw massive buying, and a 60% jump in its share price.
But for now, it doesn’t look likely that Steinhoff will follow GameStop, given that the frenzy from earlier this week has started to subside, says the most well-known short-seller in the local market, Protea Capital Management CEO Jean Pierre Verster. Verster, who has been buying (and shorting) stocks since he was a student, shot to fame after he took short positions in both African Bank and Steinhoff before the companies came close to collapse.
Verster says the GameStop saga should give short sellers pause – especially those who continue to short companies which are already heavily shorted, and that may be targeted by Reddit traders. They may have to reconsider their positions.
At Protea, they reviewed all their shorts – in roughly 50 global shares and 30 South African companies – again amid the events of the past week. Following the review, it decided not to close any of its short positions, including on Steinhoff.
Verster says ultimately this week’s review confirmed the “robust” risk management processes the firm believes it has in place, along with its diversified approach.
“We are very sensitive to shorting shares that are already very heavily shorted and we also stay clear of ‘story stocks’.” These are companies that have captured the public’s imagination and have been driven higher by investor excitement.
GameStop is a case in point, and Verster believes it will end in tears. After the frenzied buying, the company now has a market capitalisation of more than $23 billion– while investment experts believe it may only really be worth $2 billion, according to Bloomberg.
“This is some proper gambling on a company in deep trouble,” says McCurrie. He says there were very good reasons why GameStop was shorted. “It’s an old school company in the new world,” he said, adding that it is facing the same problems as a local business like Musica, which is still selling physical products amid a shift to digital demand. Clicks announced earlier this week that Musica will finally close its doors in May.
“Ultimately the share price of a company and its real value do start to converge over the long term – it’s akin to gravity,” says Verster.
He believes that prices move closer to the fair value of a company (the present value of its future cashflows) in the end, and that people who have aggressively bought above fair value may face large losses.
Short-selling on the JSE
Short-selling has been part of the local market for more than two decades, and at times has been blamed for large market movements.
For example, aggressive short selling was apparently prevalent during the near-collapse in Sasol’s share price in March last year.
Ultimately, though, many who bet against Sasol during that time ended up with large losses, says McCurrie. Within two weeks after reaching a low point in March, Sasol’s share price rocketed by 200%.
Repeated attacks on Capitec by short-selling outfit Viceroy also failed in the end.
While there is very limited data about short selling in South Africa, Verster says it doesn’t seem as if there has been much growth in short positions in recent years, since the hedge fund industry is still tiny in South Africa, in comparison to the size of the traditional fund management industry.
So for example, according to data from the financial analytics firm Ortex, the short positions in Steinhoff are only equivalent to 6% of its market value, says Verster. In GameStop, it's more than 100%.
If anything, small and mid-sized shares may have seen less short-selling as trading activity in these companies decreased – given the weak state of the local economy, he adds.
And with the relatively small pool of individual retail traders, it is unlikely that South Africa will see its own GameStop phenomenon, says McCurrie.