Melvin Capital
From Invertopedia, the encyclopedia of how things fail
Melvin Capital was a hedge fund founded by Gabe Plotkin in 2014 that started 2021 with about $12.5 billion[1][2]. It was short GameStop when retail traders organised on Reddit piled into the stock, and the fund lost 53% in January 2021[2][6]. Citadel and Point72 put in $2.75 billion to steady it[1], but Melvin finished 2021 down 39% and told investors on May 18, 2022 that it would wind down its funds[3][4].
Contents
The bet
Melvin had returned an average of 30% a year since 2014, and short bets were part of its book[1]. One of them was GameStop, a brick-and-mortar video game retailer[1][6]. By the end of 2020 so many investors were short the stock that short interest stood at 109.26% of its shares outstanding[7].
The bet was that the business would keep shrinking and the share price would follow. A short seller's gain is capped at the price of the stock, but its loss has no limit if the price keeps rising.
What happened
| 2014 | Gabe Plotkin, who spent eight years at Steve Cohen's SAC Capital, starts Melvin Capital.[1][2] |
|---|---|
| Dec 31, 2020 | GameStop's short interest hits its high of 109.26% of shares outstanding.[7] |
| Jan 11 – 13, 2021 | Chewy co-founder Ryan Cohen is named to GameStop's board. Two days later the stock jumps from $19.95 to $31.40 on about 144 million shares, against about 7 million the day before.[7] |
| Jan 25, 2021 | After a 15% loss in the first three weeks of the year, Melvin takes $2 billion from Citadel and its partners and $750 million from Point72.[1] |
| Jan 26, 2021 | Melvin closes out its GameStop short in the afternoon after taking a large loss. Plotkin says talk of a bankruptcy filing is false.[6] |
| Jan 27 – 28, 2021 | GameStop closes at $347.51, then touches $483 during trading the next day. Several brokers restrict buying in the stock on January 28.[7] |
| Jan 31, 2021 | Melvin is reported down 53% for January, ending the month with just over $8 billion despite the new money.[1][2] |
| 2021 | Melvin finishes the year down 39%.[3] |
| Jan – Apr 2022 | The fund loses 23% in the first four months of the year. A plan to shrink the fund and change its fees angers investors, and Plotkin apologises.[3] |
| May 18, 2022 | Plotkin tells investors he will liquidate the funds and return the cash, and stops charging management fees from June 1.[3][4] |
The kill shot
Melvin was short a stock that was more than fully shorted, so when buyers piled in there was no cap on the loss and very little room to get out.
With short interest above 100% of the float, every short seller needed to buy the same scarce shares back at the same time[7]. In January 2021 GameStop's intraday price rose about 2,700% from its low on January 8 to its high on January 28[7]. The SEC staff found that short sellers buying to cover likely pushed the price up during some periods, though that buying was a small share of all buying[7].
Melvin closed the position on January 26, before the peak, but by then the damage was done[6]. The $2.75 billion from Citadel and Point72 kept the fund alive, but it did not bring back the lost capital, and Melvin never earned it back[3][5]. In Plotkin's letter, he said he had "given everything I could, but more recently that has not been enough to deliver the returns you should expect"[4].
Red flags ignored
- Short interest over 100%. More shares had been sold short than were available to trade, which meant any rush to cover would have to fight over the same shares.[7]
- The crowd could see it. GameStop's high short interest was being discussed on Reddit as early as 2019 and 2020.[7]
- Capped gain, uncapped loss. The most a short can earn is the share price. A rise of more than 1,600% in just over two weeks has no such limit.[7]
- One position, one month. A fund that had averaged 30% a year lost 53% in a single month.[1][2]
The cost
Melvin went from about $12.5 billion at the start of 2021 to just over $8 billion at the end of January, even after $2.75 billion of new money[1][2]. It lost 53% in January and 39% over the year[2][3], then another 23% in the first four months of 2022[3].
When Plotkin announced the wind-down, the fund had about $7.8 billion left[3][5]. Short sellers as a group had lost more than $5 billion on GameStop by January 27, 2021, according to S3 Partners data cited by CNBC[6].
The inversion
Never take a trade where you can't name your worst loss. If a short is crowded and the crowd on the other side can see it, size it as if the price can double and double again, because it can.
What survived
The backers. Citadel's flagship fund lost less than 1% on its Melvin stake in January 2021[2]. The SEC staff later concluded that hedge funds as a whole were not significantly affected by GameStop and the other meme stocks[7].
The questions. The SEC staff's October 2021 report on the episode named four areas for further study: why brokers restrict trading, game-like trading apps and payment for order flow, off-exchange trading through wholesalers, and short selling[7].
References
- ^ “Ken Griffin's $2 billion bet”. Bloomberg via Crain's Chicago Business, January 25, 2021 (archived). The $2.75 billion rescue ($2 billion from Citadel and partners, $750 million from Point72), the 15% loss in the first three weeks, $12.5 billion at the start of 2021, 30% average returns since 2014, and Plotkin's SAC Capital background.
- ^ “Melvin Capital ends month with over $8 billion in assets after GameStop losses”. Reuters via The Globe and Mail, January 31, 2021. The 53% January loss, $12.5 billion to more than $8 billion, the 2014 founding, and Citadel's flagship losing less than 1% on its Melvin position.
- ^ “Melvin Capital to shut after heavy losses on meme stocks, market slump”. Reuters via Kontan, May 18, 2022. The 39% loss in 2021, the 23% loss in the first four months of 2022, about $7.8 billion at the end of April, the liquidation plan, and the abandoned plan to shrink the fund.
- ^ “Melvin Capital says it's winding down funds and returning money to investors during market turmoil”. CNBC, May 18, 2022. The wind-down, Plotkin's letter, and no management fees from June 1.
- ^ “Plotkin Shuts Melvin Hedge Fund Reeling From Redditor Attack”. Bloomberg via Bloomberg Law, May 19, 2022. The shutdown letter and $7.8 billion in assets.
- ^ “Melvin Capital, hedge fund targeted by Reddit board, closes out of GameStop short position”. CNBC, January 27, 2021. The short closed on Tuesday afternoon, January 26, the denial of bankruptcy talk, wallstreetbets, and short sellers' losses of more than $5 billion per S3 Partners.
- ^ “Staff Report on Equity and Options Market Structure Conditions in Early 2021”. U.S. Securities and Exchange Commission staff, October 14, 2021. The primary record on GameStop: short interest of 109.26% on December 31, 2020, the January 11 and 13 moves, the $347.51 close and $483 intraday high, the 2,700% rise, the January 28 broker restrictions, the short-covering analysis, the hedge fund finding and areas for further study.