It’s a sign of just how much is happening in 2021 that the so-called GameStop Saga already feels like an old news story. In fact, it only happened a couple of weeks ago and Wall Street is still trying to come to terms with the implications. Money managers (and hedge funds in particular) have certainly not moved on just yet, even if the world’s interest has waned.
If you need a recap of the GameStop saga, it is relatively straightforward. Stock traders game the system by doing what is called “shorting” a stock. They identify a stock that is likely to drop in value. Then they borrow stocks of that company from brokers and sell them. When the value of the stock drops, they buy them back, returning them to the broker and keeping the difference in value.
Hedge fund managers had identified GameStop as a stock that was considered overvalued. With GameStop going the way of Blockbuster, this was a relatively straightforward call. However, people on a subreddit (or group) called WallStreetBets got wind of this and decided to beat the big investors at their own game.
Members of the subreddit collectively bought GameStop stocks, causing the value to skyrocket. Now, hedge funds had sold GameStop stock at a much lower price than what they would have to pay to buy it back. They were forced into a cycle, selling off more GameStop stock and digging themselves deeper into trouble.
This led to a number of hedge funds losing what potentially amounts to billions of dollars. It also struck fear into the hearts of money managers around the country and has led to what may be a reckoning regarding unregulated Wall Street practices.
Why the money management sector is in trouble
This story is obviously not about GameStop, which only played a passive part in the events. Rather, it is a reckoning that many consider long overdue. Stock trading in the US has been left largely unregulated. This has allowed individuals and groups with huge amounts of capital to essentially use Wall Street as a casino, making money by talking calculated gambles.
To many outsiders, it can seem like a microcosm of unchecked capitalism. The rich play games with huge sums of money while everyone else feels like an outsider. WallStreetBets made it possible for regular people to not only get involved but make significant waves.
Predictably, investors have not taken well to this saga. Many are now calling for regulations on the stock market, again making “regular” people feel like the system is rigged against them. But in the short term, it is the money management sector facing a lose-lose proposition.
The problem they face is twofold. It is clear that people have figured out how to game the system. When WallStreetBets pulled off the GameStop coup, only a small percentage of people knew of its existence. Now millions more know not only about the subreddit, but about shorting and other trading strategies. Not only can this be done again, but it is likely to be even more monumental the next time it happens.
In other words, money managers are in trouble unless they can find a way to stop what is currently perfectly legal trading.
However, that would mean increased regulation, which would have a long term impact on the money management sector. It would protect them from the whims of WallStreetBets, but it would also protect the stock market from their own practices.
This has huge implications not just for hedge fund managers but for the economy as a whole.
How big is the money management sector?
Because most people know little about it, it is easy to think of the money management sector as niche. The reality is vastly different. According to a Boston Consulting Group estimation, in 2019 there was $89 trillion worth of assets under management. Hedge funds alone account for approximately $3.2 trillion.
In other words, money managers are working with more wealth than many countries’ entire economies. Wealth management is a monolithic establishment.
That said, this value does not amount to what is being invested in the stock exchange. Furthermore, not all of the money invested in the stock market is used to game the system by shorting or similar practices.
It is therefore the hedge funds and robo advisors that are panicking more than anyone.
The biggest losers
There are many money management companies in play in 2021. Some of them are hedge funds that cater to the super-wealthy, while others make trading accessible to the regular individual. Companies like Wealthsimple are among the latter.
Wealthsimple is what is called a robo advisor – they are the largest in Canada. Robo advisors carry out trades for anyone willing to invest the money. This Wealthsimple review highlights its positives to give you a clear idea of the purpose of a robo advisor.
Robo advisors have become consistently more complex over the years, finding new ways to use the stock market to grow the money of individuals and companies. Robo advisor companies are panicked for a couple of reasons. For one, WallStreetBets has shown people that it is possible to trade without the use of a middleman or broker.
For another, regulations could prevent robo advisors from making many trading decisions that succeed by gaming the system. Algorithms that have evolved over years may need to be redesigned so as not to contravene new regulations.
It is not just the creators of robo advisors that may have to rethink everything. Hedge funds are currently teetering on the edge of the unknown. Hedge fund managers cannot suddenly stop using strategies like shorting because of the possibility of another “GameStop.” These are an integral part of the way they operate.
For now, hedge funds either have to continue as they did, with a real possibility that an internet movement could lose them billions of dollars, or scramble to come up with less risky ways of trading that still grow their wealth.
Considering that the money management sector was not at all prepared for the GameStop saga, it is difficult to say what will happen next. GameStop itself has already lost much of the value it gained, but maintaining the valuation of one failing company was never the point of the WallStreetBets movement.
Online, people are speculating about what will be the next GameStop. Dogecoin – a cryptocurrency based on a meme – has been punted by a few publications, but since it is a cryptocurrency and not a stock, the impact of Dogecoin’s rise will not necessarily impact money managers in the same way.
It will be interesting to see how hedge funds and robo advisors navigate the next few months. They have learned that the system is not as foolproof as they thought, and may need to take drastic steps to stay both afloat and relevant.