How One Hedge Fund Manager Is Using The Retail Investing Frenzy To Turn A Profit

Retail investors have become a force to be reckoned with over the past few years, but what does the dramatic increase in retail activity mean for hedge funds and other institutional investors? Moez Kassam of Anson Funds has been tracking retail investing activities and their impacts on the broader market.

In a recent interview and his quarterly letters over the last two years, he explained how he put what he calls the “Robinhood army” to work for Anson. His methods fly in the face of the goal of many retail investors, which was to make hedge funds pay for shorting stocks.

Beware meme stocks

Although Kassam has been tracking the retail phenomenon in the stock market since at least the beginning of 2020, it fully entered the spotlight when retail traders pushed GameStop’s valuation to eye-popping levels in a matter of days.

“In January of [2021], the David versus Goliath story played out in the markets in dramatic fashion as the retail crowd ganged up on large hedge funds such as Melvin Capital,” he wrote in his first-quarter letter for 2021. “The resulting short squeeze led to the ‘Blockbuster for video games’ rocketing in value 26x in less than a week!”

In his Q2 2021 letter, Kassam wrote that meme stocks went”  ‘to the moon,’ fueled by online coordination in Reddit forums like Wall Street Bets.” He also called attention to AMC Entertainment, which enjoyed a meteoric rise of about 600% in the middle of the second quarter of 2021.

“Recall that AMC is a highly stressed company that allows consumers to watch movies in theatres, a declining consumer behavior like purchasing physical newspapers,” he wrote. “AMC was also battered more than most by the COVID‐19 pandemic. Yet despite its highly compromised position, the stock increased from a low of $12 per share in late May [2021] to an intraday high of $73 per share in early June, as the Robinhood Army adopted the stock in a frenzy of coordinated activity.”

How retail investors took the stock market by force

In an interview, Kassam explained how retail traders became such a significant force in the market.

“Retail investors have become a genuine force to be reckoned with,” he said. “We are living in an environment in which interest rates are at zero or near zero, and many retail investors have given up on fixed income altogether. Their entire portfolios consist of stocks, and now some additional high-risk assets like crypto. And we’ve had a bull market, more or less, since March 2009, and so you’ve seen an acceleration of risk-on behavior. Retail has embraced the most speculative corners of the equity markets and they’ve added leverage into the mix. It’s quite the dynamic.”

He added that people used to use Interactive Brokers or TD Ameritrade. However, many are now using platforms like Robinhood, which has made trading easier and faster than ever before with its smartphone app.

“Unlike existing online trading platforms, Robinhood has an easy‐to‐use smartphone application and a website geared towards the younger generation (Millennials and Gen Z),” Kassam wrote in his second-quarter letter of 2020. “The platform is as easy to use as a video game and lets users invest in stocks with zero trading commissions, purchase fractions of shares, and start trading with as little as US$100.”

He noted in another letter that Robinhood’s user base has been growing by millions of users per quarter. In his Q1 2021 letter, Kassam said that the “Robinhood army” was “fueled by excessive disposable income alongside boredom due to COVID shutdowns,” driving “stock prices and volumes of small cap equities to dizzying heights.” 

“Robinhood traders appear to exhibit both Fear of Missing Out (FOMO) and herd mentality thinking,” he added in his Q2 2020 letter. “This situation leads to crowds of Robinhood traders, often in contact with one another via social media platforms, all piling into the same equities in such a way that materially impacts price and volume.”

How retail sentiment drives stock prices

Those who frequented the Wall Street Bets forum on Reddit became the center of attention in 2021 due to their coordination in buying heavily shorted stocks. They egged each other on, urging each other to buy certain stocks that were heavily shorted by hedge funds.

Retail investors also used social media to organize their efforts and sought stocks with sizable amounts of positive sentiment. It poses a significant opportunity for hedge fund managers like Kassam, who know how to use the retail segment to their advantage. However, other hedge funds that don’t take into account the impact of retail investors could find themselves facing sizable losses.

Kassam gauges the retail sentiment he sees on social media and analyzes it to determine his next move, often taking a wait-and-see approach. He also utilizes keywords in his analysis as he looks for signs that sentiment on a particular stock is about to switch.

He looks for a divergence on platforms like Twitter and signs that investor comments are shifting from positive to negative or vice versa.

“That’s when it’s a good time to get in on the short side or the opposite, if looking at a long,” Kassam said in the interview. “We’ve adopted our strategy not to just look at fundamentals but also sentiment on Stocktwits, Twitter and other platforms. These guys tell you what they think, they coordinate with each other, and they have scale. You have to pay attention.”

How Kassam’s strategies work

For example, Anson Funds did well during Q2 2020 due to its shorts on companies whose valuations were driven higher and higher by retail investors.

“The largest positive contributors in this strategy came from shorting companies whose stock prices were bid up by retail traders to nonsensical levels after these companies had already declared bankruptcy (or were near declaring),” Kassam wrote in his quarterly letter. “These included Hertz (HTZ), Whiting Petroleum (WLL), Chesapeake Energy (CHK), and Latam Airlines (LTM).”

In his fourth-quarter letter for 2020, Kassam said Anson generated a “meaningful positive return” for the year, “thanks to a level of retail speculation not seen in decades.”

“While the hype provided a broad opportunity set, it also posed challenges for the strategy with longer tails of investor euphoria and asset inflation,” he added. “… Liquidity remains abundant and retail speculation continues unabated. We aim to be even more nimble and reactive until market conditions change. The goal of this strategy is not to ‘call the top,’ but to trade the ebbs and flows in retail sentiment.”

Another strategy Anson uses to capitalize on retail sentiment involves SPACs and their warrants.

“We typically buy SPACs at or near their $10/share issuance price and then capitalize on retail enthusiasm as transactions are rumored or announced in hyped industries (particularly ESG names),” Kassam explained. “All the while having the $10/share redemption price secured in U.S. Treasuries that essentially limited our downside risk (a feature of every SPAC).”

An additional data point

Kassam’s strategy also relies on looking at the number of posts on each stock and analyzing the trade data.

“Most people look at the [trade] volume as a metric, but we look at what percent of the volume is retail,” Kassam explained. “Prime brokers are looking at the average trade ticket and trade size, but we get a much better idea of who’s buying and selling a stock by looking at the average dollar ticket.”

He tries to determine how many social media posts are just noise and admits that there can sometimes be false positives around dark pool trading. However, Kassam has found a way to identify why many retail investors are in a stock, especially now as people start to actively manage more money on their own, like through their own brokerage accounts or 401k.

“This community is younger and more wired,” Kassam pointed out. “They go online to tell you what they think, and what they’re going to do. You need sophisticated methodologies to translate this information into a hypothesis about the direction of a stock price, and that’s what we do.”

A final warning for retail investors

Kassam makes sizable returns by shorting companies. He said in the interview that it isn’t enough to short companies that are overvalued. Instead, he targets companies he sees engage in highly questionable activity and behavior by insiders.

Retail investors’ strategy seems to focus on buying and bidding up heavily shorted stocks without regard to any factor other than the fact that many hedge funds are shorting them. As a result, the retail trading frenzy has given some potentially fraudulent companies a boost.

“This incredible retail‐driven liquidity has enabled many frauds, hyper‐promoted companies, and poor businesses with a market-friendly story to raise large sums of equity financing,” Kassam wrote in his Q2 2020 letter. “In many cases, retail investors rapidly soaked up the newly issued shares and continued to bid these stock prices upward.”

Although Anson Funds has made a name for itself as a short-seller, retail investors haven’t steered it away from trading both the long and short side. Kassam’s strategies for using retail investors’ tools against them have enabled Anson to profit from the very activities that were supposed to take a bite out of the hedge fund.