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‘If you can’t beat them…’: why institutions eye retail trends
Sharp gains in the prices of so-called meme stocks – shares that have achieved viral popularity due to social media – have punished a number of institutional short-sellers over the past 18 months or so. That has prompted a revolution in institutional investor behaviour, with many avoiding shorting stocks and paying increasing attention to social chatter on popular retail-focused sites.
How ‘Eat the Rich’ galvanised a change in hedge-fund analysis
For a brief period in early 2021, individual investors – many of them followers of a popular Reddit page – piled into trades around several companies, such as GameStop, pushing their stock prices to stratospheric levels. Short-selling hedge funds were caught out – Melvin Capital, one of Wall Street’s elite hedge funds, had to be bailed out by two other firms. The Reddit GameStop coup captured the public imagination – Netflix even made a documentary about the phenomenon, called ‘Eat the Rich’.
The meme-stock craze may now be over. That’s partly because hedge funds have changed their behaviour as a direct result of the trend. Few are willing to aggressively short stocks and expose themselves to another attack by organised retail investors.
And it’s not just US investors they need to be aware of. Indian retail investors bought stakes in most of the companies in the Adani Group in March. The Indian conglomerate’s share price plunged following allegations of accounting fraud and share-price manipulation made by the US short-seller Hindenburg Research in late January. 1
Institutional investors have now started following retail investors on social media to ensure that they don’t take another hit from meme-stock plays. Indeed, according to Brunswick Group’s Digital Investor Survey 2023, 58% of institutional investors have made an investment decision based on information they found on Reddit. 2
The same survey found that 88% of institutional investors had made a recommendation or decision based on information from digital or social media. Bloomberg has quoted Chris Berthe, JPMorgan’s global co-head of cash equities trading, as saying, ‘If you don’t have a clear view of what retail is up to, it feels like you’re driving partially blind.’ 3
Figure 1: Favoured sources of information used by institutional investors, 2023
Institutional investment firms have also hired social media managers and subscribed to services that monitor social chatter. JPMorgan, for example, has launched a new tool called ‘Through the Retail Lens’, which tracks social media activity and predicts short-squeeze opportunities. Bloomberg reported JPMorgan as saying that it hoped the tool would help drive trade ideas for clients and that some quant funds had shown interest in incorporating the product into their models to enhance alphas.
Moreover, the focus isn’t just on meme stocks but on retail behaviour more generally. During the Black Friday sell-off in November 2021, for example, retail investors were big buyers and ‘that was a real source of interest for our clients’, according to JPMorgan. That’s the kind of signal that billion-plus-dollar funds actively seek, explained Bloomberg’s article.
Clues as to the behaviour of retail investors are increasingly important because those investors represent a growing share of the overall market. They accounted for 23% of the US stock market in early February, surpassing even the pandemic-fuelled trading frenzy, when bored investors flush with cash decided to take on the institutions.
However, according to JPMorgan, the behaviour of retail investors has changed since the pandemic. While retail volume remains concentrated in smaller stocks, they are accounting for an increasing percentage of total trading volume for large-cap stocks. Moreover, retail investors appear less keen now on options trades, with these high-risk, high-reward trades accounting for about 12% of all trades in early February, down from a 17% share in early 2021. 4
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