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Michael Burry cashes in on GameStop

Hedge fund manager who made $800m on US housing market collapse has now made $270m on GameStop.
The notable character from The Big Short warns small-time investors to be cautious. Image: Spencer Platt, Getty Images

For those who read the book or watched the movie The Big Short, Michael Lewis’s telling of how a handful of people foresaw the 2008 crisis in the US housing market, Michael Burry was one of the most notable characters.

Burry, a physician by training, had stumbled into finance while studying and eventually ended up founding and running his own hedge fund, Scion Capital, in 2001.

Back then, he had quickly made a name for himself ‘shorting’ technology stocks. He thought they were overvalued and in effect made money from the ‘dotcom crash’ by betting their share prices would drop.

Though he made a lot of money from this, what he is best known for was betting against the US housing market. Scion Capital made about $800 million in the process, of which Burry got $100 million.

The film compressed how long Burry had foreseen the coming crash. He had been studying the property market since 2005, not just a few months, so by the time the crash eventually happened he had known for years that the market was built on a shaky foundation.

Unhappy investors

What the movie got right was the displease of Scion Capital’s investors in Burry when it came to his insistence that the market was about to crash and him pushing through with a strategy of buying credit default swaps – a form of insurance on mortgage debt.

Credit default swaps see the seller (in Scion Capital’s case Goldman Sachs) paying out the buyer for the face value of the loan if there is a default. As part of the deal, Scion Capital would also pay Goldman Sachs a series of fees.

For Goldman Sachs, it was a good deal as it was not only selling insures on products that were literally ‘as safe as houses’, it was also getting some fees.

What Goldman Sachs did not grasp was that housing was not safe. A lot of mortgages were given to people who could not afford them. These mortgages were then bundled into financial products, which were then given investment-grade ratings and later sold off.

Despite all of this, some of Scion Capital’s investors were in open revolt against Burry’s investment strategy, as they did not see any signs of a coming crash. Burry, in an interview with 60 Minutes, said the animus was so great they were still angry with him, even after he made them tens of millions of dollars.

A new game

After the 2008 financial crisis, Scion Capital was closed and Burry disappeared from the limelight somewhat. Then in 2013 he reopened his hedge fund, this time naming it Scion Asset Management.

For the last few years, Scion Asset Management has gone relatively unnoticed. But in August 2019, it announced that it had bought three million shares worth $16.56 million in gaming and electronics retailer GameStop.

It later emerged that Scion Asset Management had sent a letter to GameStop’s board, asking it to buy back $300 million of its own shares, to boost the value of its shares.

GameStop seemingly took this advice as it bought back $198.7 million in shares between July 31, 2019 and January 31, 2020.

Small-time investors on the internet forum Reddit took note. They knew of Burry’s reputation and stated watching the stock.

Bad call

They were not the only ones taking note of GameStop. Some hedge funds saw an opportunity to make money by shorting it.

Read: ‘Game over’ for hedge fund

But the hedge funds got their sums wrong. In order to short a stock, there must be enough shares in the open market for them to ‘borrow’. With only 27.29 million of GameStop’s total 69.75 million shares outstanding freely traded, this meant only 39.12% of its shares were available to be traded.

By the time Ryan Cohen, founder of online retailer Chewy, had taken a 13% holding in GameStop on January 11, it was clear that the funds would have to scramble to buy enough stock to return to whoever they ‘borrowed’ it from, as Cohen’s involvement now signalled a positive change in the group.

This saw the small-time investors spring their trap. They bought up GameStop shares and waited till the hedge funds started pushing up the price by panic buying.

This spike in the price saw Scion Asset Management’s holdings rise from $17.37 million at the end of September to about $271 million at its peak.

Read:

Trade with caution

Although his holding in GameStop worked out well, Burry urged the small-time investors to trade with caution.

In a since-deleted tweet, he said: “If I put $GME [GameStop] on your radar, and you did well, I’m genuinely happy for you. However, what is going on now – there should be legal and regulatory repercussions.

“This is unnatural, insane, and dangerous.”

Burry has a point. He knows what he’s doing and made a lot of money making calls against the prevailing market views.

Investors who just invested in a company because he took a holding in it are not really investing, they are gambling. And any gambler who’s made their money should know to leave the table with their winnings, rather than further chance their luck.

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COMMENTS   10

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Surely it is a free market?

Confused about the chronolgy in the story (from a luddite on this stuff). Was the initial move by Burry before the hedge funds shorted the stock or after….? Did he buy because he saw the short or did the hedge funds move after Burry bought (which does nor make sense to me)? How did the Reddit crowd know the stock was being shorted..? It sounds as if more than 100% of the stock was either bought or shorted, is that be possible?

I had read a bit prior to the MW article so hopefully I can help. Burry purchased shares in the company prior to the hedge funds shorting the stock. After his purchase and some positive news for Gamestop, the share price went above a level that other hedge funds thought was a reasonable level so they shorted the stock. In essence, one hedge fund (HF) bet the price would go up, the other HF bet it would go down. Very normal.

Shorting a stock has limited capacity for gain – if a stock is $10, the most you can make is $10 if the share price goes to zero. Purchasing stock (otherwise known as ‘going long’) has infinite upside.
In order for the shorting HF to increase the profit they approach a broker for shares to sell for the short. People then buy those shares BUT if the shares are held by the brokerage, the broker can again offer those shares for a short. This then allows for a single share to be shorted more than once. In this instance it went to 140% of the total shares – which is what has caused all the interest. If people don’t sell the shares when the HF is trying to cover their short (i.e. repurchase the shares to give back to the brokerage) – the HF is then in breach of contract so they need to offer a higher price until people eventually sell – a ‘short squeeze’

thanks, a-c.

1. so when the shorts have bought what they need, the share will tank back to where it was, correct?

2. how did the amateurs on Reddit and the WS blog (no offense to amateurs I am one in this field) know that at least 2 HFs shorted the stock? Is this common knowledge in the industry? Can you look it up somewhere? Because I would have guessed that anyone with a short position would guard the info with their life, no?

@boepens, the HF short info was disclosed in regulatory filings to the SEC for the 3rd quarter 2020.

HF generally go to great lengths to guard their short positions. If they use put options, for example, they buy them over the counter (OTC) which means they don’t have to list them in regulatory filings.

Basically someone has to lose for a short seller to gain.
At 140% of the shares outstanding…naturally people are buying / selling these financial “instruments” and betting against each other for more than the companies is actually worth.

Factor in that all of this (in this case) has even LESS to do with the company’s actual value – and it’s just a bizarre situation.

Personally I don’t think instruments allowing shares to be sold more than once should be allowed, but that’s just me.

So true: there is a huge difference between investing and gambling.

It’s a fascinating story and turn of events.

What stops hedge funds trying to push bad news on companies they short to help drive the price down? Not much. And who knows what other tricks they use that regulators haven’t stopped (I mean when you’re on the hook for millions…)

So retail investors gambling via Reddit should also be allowed.

Not for me personally – but fun to watch

YOLO’s – You Only Live Once …. gotta luvvit!

If you cant stand the heat, get out of the kitchen.

End of comments.

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