Renegade investors herald a new business future

This week may well have been one of the most interesting and captivating in US stock market history.
A few stocks, GameStop, Nokia and AMC, became battlefields on which hedge funds, including the US investment giant Melvin Capital, were targeted by young day traders investing through new brokerage platforms such as Robinhood and coordinating via posts on Reddit.
The results were as entertaining as an episode of “Game of Thrones,” with most observers and circulating memes on social media depicting it as a battle between the Lannisters and the Wildlings, millennials versus boomers, or a revenge attack against the culprits of the 2008 global financial crisis.
A short summary of how hedge funds operate is a necessary start. Firms raise capital from investors and then invest these amounts in liquid assets based on different strategies. To simplify, they mostly make two assumptions when investing in a stock. If they think the company will do well and the stock will gain in value, they maintain a “long” security position, and so will buy the stock today, hold it and sell it in the future. If they think the stock will lose value, they take a “short” position, and through a mechanism will sell it today (by borrowing the stock) with the aim of buying it in the future at a lower price (and giving it back).
The real key to all of this and the hidden actor of this story is leverage: For a single dollar of equity, hedge funds will borrow money and invest it. So, their exposure is leveraged and bigger than the initial amount of capital. If things go as planned, they will multiply the gains for their investors. However, if things go the other way, then they will multiply losses. Hedge funds usually announce these short positions against companies to create a momentum in their favor. Sometimes it can backfire.
There is in essence nothing new about what happened this week. The novelty is that the GameStop “short positions” of Melvin Capital were squeezed not by one of their peers but by a group of young retail investors coordinating through the WallStreetBets page available on Reddit. Basically, these investors encouraged the purchase of the most shorted stocks, pushing the prices up and, hence, multiplying the losses of hedge funds. These events were accelerated by SMEs being shattered due to the pandemic lockdowns. The resulting uncertainty and frustration offered both time and a reason to unite against hedge funds that were betting against businesses.
The story does not end here. In an unexpected twist, and with the WallStreetBets crowd about to defeat the funds, activities on the main “battle stocks” were halted on brokerage platforms, bringing the stocks prices down and saving the hedge funds for the day.
This shifted the entire situation, with the WallStreetBets crowd crying foul and claiming that the reason for the sudden shift was that Citadel, an investor in Melvin Capital but also Robinhood’s biggest client, forced the platform to halt trading to preserve its investments.
Without getting into politics, it might be the first time that Alexandria Ocasio-Cortez and Donald Trump have been on the same side, with both attacking the hedge funds and defending the young traders. Later in the day, Robinhood said that this was not the reason, claiming it was a regulatory issue.

Like legacy players in other industries before them, and as new technology adoption gains momentum, investment firms are waking up to a world of disruption and punishment in which COVID-19 acted as a catalyst.

Khaled Abou Zahr

Despite the fallout involving Robinhood, this new investment activity empowered by the brokerage platform and its peers has been hailed as giving people the same power and advantages that hedge funds previously monopolized.
However, this innovation still relies on old business rules and procedures, and even if this battle is over, the war will certainly continue — a fight between transparency and opacity, along with an unstoppable reduction in the intermediaries involved.
The impact on the future of the industry and business is without doubt. This is about more than just “shorting stocks,” it is about the birth of a new paradigm for investment and business that has been empowered by technology. It reveals the power of digital platforms and that as decentralized networks make their way, intervention will become even more difficult. This will also prompt regulators and government bodies to try to tackle Bitcoin and the crypto environment with greater authority.
It also signals the advent of a new breed of business leader and investor, symbolized by three figures — David Portnoy, Elon Musk and Chamath Palihapitiya. While all three have different backgrounds, each stood with the crowd investors. What do these business leaders have in common? Transparency and a fan-centric approach to business. They are transparent and open about their business choices and decision processes, communicating with their followers, and allowing them to gain from their experience and decisions. There is generosity in this approach, but obviously also a self-serving interest. It is nevertheless a positive message of empowerment and leveling the playing field in a time of high wealth disparity.
Like legacy players in other industries before them, and as new technology adoption gains momentum, investment firms are waking up to a world of disruption and punishment in which COVID-19 acted as a catalyst. The only things that do not seem to be disrupted are the over-leveraging of the global economy, the growing bubble, and the need for a scapegoat when they all implode.

• Khaled Abou Zahr is CEO of Eurabia, a media and tech company. He is also the editor of Al-Watan Al-Arabi.