Here’s How Bearish Investors Act When Stocks Fall | Financial markets
The Germans have a word for a feeling of joy at someone else’s evil:gloat. Instinctively, this seems reprehensible, but there is a type of player in the financial markets who constantly experience this feeling. They are bearish investors. Free investment funds (hedge funds(in the jargon) specialized in taking short positions in listed companies in the hope that their value would plummet. Its profitability and the salaries of its managers directly…
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The Germans have a word for a feeling of joy at someone else’s evil:gloat. Instinctively, this seems reprehensible, but there is a type of player in the financial markets who constantly experience this feeling. They are bearish investors. Free investment funds (hedge funds(in the jargon) specialized in taking short positions in listed companies in the hope that their value would plummet. Its profitability and the salaries of its managers are directly proportional to the unrest and ruin of the shareholders of the attacked companies.
The latest victim in Spain is Grifols, a Catalan group specializing in the business of extracting and selling blood plasma. 12 days ago, the mysterious Gotham City Research firm released a scathing report calling into question some of the listed company’s accounting and management practices, causing its shares to plummet 40% in just four sessions.
In the collective imagination, these types of investors have an aura of mystery. Greedy and unprincipled characters who are not averse to trampling and lying in order to earn money. The reality is somewhat more prosaic and in fact their way of action is not only not prohibited, but also has many defenders. They argue that this will bring greater transparency and liquidity to financial markets. But how do they actually work? How do they make money by devaluing a financial asset?
An example of ancient coins
Bill Ackman – one of the managers hedge funds the most famous in the world. The New Yorker amassed a $4 billion fortune running Pershing Square Capital Management. Under his leadership, the fund launched the bloodiest bear war in history: it took a $1 billion short position in the health food company Herbalife. Documentary Everything to zero (Ted Brown, 2016) recounts the financial, legal, and social conflict that ensued over this bold bet that Ackman ultimately lost.
When asked in the documentary how he would explain to a lay person how bears operate, Ackman gave the example of currencies. “Imagine you have $10,000 worth of ancient coins. A bearish investor who doesn’t think they’re worth much would borrow them from you for a while in exchange for paying rent. The bearer, having received your coins, will sell them on the market for $10,000 and wait until they drop in value. Now think that after some time these currencies will depreciate by half. The investor will only have to buy the coins and return them to you, keeping the difference,” Ackman explains in the documentary.
That’s exactly what they do hedge funds. When they realize that a company is in serious trouble due to high debt, shortcomings in corporate governance or possible fraud, they go to the market to borrow shares of that listed company. Once they are in their possession, they sell them and wait for their value to depreciate so they can buy them back and pocket the difference.
Equity loan and maximum risk
But who borrows the shares? Any owner of exchange-traded securities can use them for lending or providing collateral for other transactions. Typically, large pension funds and other long-term shareholders lease the portion of the company’s shares that they control. They have a clear understanding of the investment and don’t care if the value fluctuates. Thanks to these contracts, they are able to earn additional profits compared to simply holding stocks in their portfolio. The risk they are taking is that during the life of the loan they will not be able to dispose of the securities, no matter what happens to the company.
Explained this way, it seems like it’s easy to make money on bearish positions because they allow you to invest without owning the stock. But the risks associated with this type of surgery are enormous. When someone buys a security, the most he can lose is all the money he invested. 100%. On the other hand, the losses of a bearish investor have no limit. If you sell a security worth $50, what happens if it’s worth $100 a few months later? You will have to go to the market to buy back the shares at this price. What if they go up to $200? Or 1000 dollars? The potential losses are endless.
The risk for someone borrowing shares is that hedge funds who made a short position does not return titles. For this reason, lenders are very cautious in requiring specific guarantees related to changes in value. The more the price rises, the worse the situation is for the bear, and the more collateral assets will be needed to continue lending him shares. And a higher interest rate.
This is not the only formula that allows you to bet on a decrease in value. An individual investor owns inverse exchange-traded funds: securities that he or she can buy or sell that rise in value when the underlying asset falls. Alternative options for short bets include selling futures and buying put options, as do new formulas (which are viewed with suspicion by regulators) such as CFDs. Either way, the result is the same: if the asset falls, the investor wins; If he goes up, he loses. And you can lose a lot.
GameStop: Rich Bear Juice
Bear funds live in an upside-down world – in the purest style Alice in Wonderland, Lewis Carroll – where they invest money not by buying shares, but by selling them and where devaluation is synonymous with profitability. In this universe, one of the craziest situations in financial markets could happen: short squeeze, which can be roughly translated as “bassist squeeze”. This circumstance usually occurs with securities that have been punished in the stock market and in which short investors have a very significant position in their shares.
In these cases, a small piece of positive news causing the stock to rise forces bears to buy the stock to return it to their owners and thus limit losses. But these forced purchases end up causing the value to rise even further, in an upward spiral that could ultimately lead to the downfall of many hedge funds, as happened two years ago with the GameStop case, whose shares multiplied their value by 30 in one month because of this dynamic. .
This company owns a chain of video game stores, a business with a turn-of-the-century flavor. Little by little their accounts deteriorated and the price fell. The hedge funds saw her as a wounded gazelle and pounced on her.
What they didn’t expect was that resistance would begin to form in an unknown online forum. Gamestop’s defenders, many of them young people just starting out in the world of investing, decided to fight back. Having coordinated their actions and encouraging each other, they began to buy shares of the company, which were trading at bargain prices. Gradually the price recovered, triggering the famous short squeeze. Bearish investors were caught out by the overvaluation and were forced to start buying shares in the market to pay back the securities they had borrowed and cover the guarantees. The spiral began to grow and grow like a tornado, collecting water in the Caribbean Sea and then throwing it onto the Florida coast.
Internet forums were winning more and more with their bet to save Gamestop, and the bears were forced to leave in horror. In a matter of months, the company’s stock price rose from less than a dollar to over $80. Hedge fund losses amounted to several hundred million dollars. The story is so amazing that even Hollywood made a movie: Wall Street hit (Craig Gillespie, 2023).
Bet against the country
Not all bear investors have such an active profile as in the case of Grifols or as happened with Herbalife. In many cases hedge funds They combine conventional investments with short-term bearish bets. Sometimes fund managers are clear that the sector will do poorly, as happened in 2011 and 2012 with Spanish banks that had many short positions of their shareholders. So much so that the CNMV has temporarily banned them.
During those dark times, bets were directed not only against financial institutions, but also against Spain’s public debt. Every time the risk premium rose, it meant another degree of misery for the public accounts and another bottle of champagne uncorked in the City of London. hedge funds Bears sense market inefficiencies and attack for the jugular. Perhaps the most famous case in history is the challenge of the famous investor George Soros against the British pound, which ultimately broke the hand of the Bank of England itself and reported a profit of $1 billion to its fund.
Bearish hedge funds identify market inefficiencies and attack the jugular. Perhaps the most famous case in financial history is legendary investor George Soros’ challenge against the British pound in 1992, which ended by bending the Bank of England’s own hand and reporting a $1 billion profit to its fund.
16th century practice.
These short bets on stocks or bonds may seem like modern times, the latest virginia of financial capitalism. But in fact, the first recorded bearish position occurred more than 400 years ago. In the early 16th century, Isaac Le Maire, one of the founders of the Dutch East India Company, considered the first listed company in the world, left his shareholding in anger. In retaliation, he developed a commercial formula to take advantage of the Company’s stock market decline. And, for that matter, he devoted himself to spreading hoaxes about ships that sank on their return to Europe. He ended up in court, but with the honor of being considered the first recorded bassist. This practice is as old as capitalism.
Ethical dilemmas
Although this gloat -rejoicing in the evil of others scares many; short bets are a completely legal practice. Regulators have tried to limit this and have temporarily banned the operation from time to time. But this is like opening the door to a field: to take a bearish position, stock lending is not the only formula. There are other contracts and derivatives that allow this type of betting.
Its proponents argue that this is the best formula for taming the markets to adequately counter the bullish thesis that company managers and their financial sponsors (credit banks, brokerage firms, consultants…) always defend. They also claim that many scams and unsustainable situations have been uncovered thanks to the bears, as happened with the Gowex case in Spain or with mortgages. subprimewhat triggered the 2008 crisis.
One thing is clear: when bears correctly understand their prey and their strategy, they manage to make the most profitable financial transactions. The best incentive for this type of investment is to have a guaranteed future. At least for another four centuries.
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