University of Southern California undergrad student Jake Freeman, 20 years old, recently made a killing of $110 million, investing in a store chain specializing in home goods. He invested about $25 million in Bed, Bath and Beyond, a company on the verge of bankruptcy about a month ago, and sold most of his stake for $130 million, after a sharp rally in the price of the stock. The price of the stock has dropped, since his exit.
One more wisp of that ethereal diffusion in which fact blends into lore to build myths, specifically, the American Dream, in this instance? It is more than that. For one, it is a warning for the benefit of unwary investors who are tempted to invest in particular stocks by information floating around in cyberspace about those companies’ forthcoming good fortune, regardless of their more sordid financials in the real world. It is also a heads-up for a regulator like Sebi, charged with investor protection.
The specifics of Jake Freeman’s investment success are as follows. He is majoring in applied mathematics and economics, that is, yet to graduate, but has been interning for years at a hedge fund, Volaris Capital. Before he turned 17, Jake co-wrote a paper with the hedge fund’s founder, Vivek Kapoor, titled Irreducible Risks of Hedging a Bond with a Default Swap. Freeman has been practising investment with his uncle for years, too. He put together Freeman Capital Management, a hedge fund, with contributions from friends and family. He bought his 6% stake in Bed, Bath and Beyond with $25 million from this hedge fund.
Bed, Bath and Beyond is a meme stock, meaning it is a stock that draws the attention of investors who frequent online chatrooms, like the (in)famous Wall Street Bets on Reddit. Meme stock investors like stocks of companies that are in financial trouble and are likely to be short-sold by professional funds. If meme stock investors manage to bid up the price of short-sold stocks, and keep them high past the deadline for delivery of stocks, then those who have shorted the stocks would be forced to buy them up at a high price, in order to have the stocks in hand to meet their obligation to deliver. This so-called short squeeze offers profit opportunities for meme stock investors.
Such a strategy won meme stock investors oodles of money from their earliest success stories, Gamestop and Hertz. But mimicking earlier meme-stock strategies is no guarantee of later success. While retail investors did manage to bring up the price of Bed, Bath and Beyond from the mid-single digits to near-30, allowing Jake Freeman to buy cheap and sell dear, the subsequent exit of an activist investor, who had acquired a 12% stake in the company, crashed the stock.
The short point is as follows. Trading strategies can detach the price of a stock from the level warranted by its fundamentals, for some time. How far above the realistic value and for how long are entirely contingent on unpredictable factors. Those who put their hard-earned money into such trading strategies are risking their savings. Freeman made good, because a whole lot of others ended up holding the can.
India is full of WhatsApp groups. Lots of them are content to add to climate change with megabytes of good morning messages and funny videos. Many also peddle WhatsApp messages and emails purvey hot trading tips and stories of the fortunes made by housewives in Harinagar or Hyderabad or some other place.
No regulator can hope to disprove the old saying that a fool and his money are soon parted. Regulators can, however, alert investors to the risks of relying on stock tips and amateur trading strategies, whose success stands on the stilts of tall stories and, probably, fraud.
Investor education and creation of opportunities for reliable investment with low transaction costs are the surest instruments of guarding against investors being taken for a ride, by either their own greed and lack of sense or the subterfuge of fraudsters. Sebi needs to take a proactive approach to guard against novice retail investors being misled by misinformation on facts or trading strategy.
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