Hedge Funds Hunt Frothy Names to Short, Even After GameStop

Hedge Funds Hunt Frothy Names to Short, Even After GameStop

Many hedge fund stock-pickers who rang up benchmark-beating returns in 2020 expect to repeat that feat for a second straight year, even after the Reddit rabble-rousers bloodied some short sellers.

They’re betting that rock-bottom interest rates, government stimulus and vaccine rollouts will push stocks higher. And they see irrational exuberance from retail investors creating a target-rich environment on the short side, too, after stocks like GameStop Corp. and AMC Entertainment Holdings Inc. rocketed to heights that quickly proved to be unsustainable.

Read more: GameStop Rout Erases $28 Billion as Stock Dips Below $100

Pandemic-driven volatility made last year one of the best in a decade for many equity hedge funds. Several posted gains that were more than double the 18% total return for the S&P 500, and some tech-focused funds outpaced the Nasdaq Composite Index’s 45%.

This year, stock-pickers predict they’ll find the best buying opportunities outside the U.S., where valuations are deemed less frothy. They’re buying travel-related companies like Dufry AG, the operator of duty-free shops, that were beaten down during the pandemic, as well as those that prospered during the health crisis and whose earnings power may prove to be enduring, such as Japanese food-delivery service Demae-Can Co.

Read more: Hedge Fund Heavyweights Look Beyond U.S. to Extend Hot Streak

On the short side, they’re targeting some of last year’s best performers -- those with businesses that will be less robust once people return to their pre-pandemic routines -- as well as industries that may languish because of altered consumer tastes or habits, such as movie-theater operators like AMC.

If the first month of 2021 has taught managers anything, it’s that shorting can be perilous. Gabe Plotkin’s Melvin Capital Management lost 53% on his short bets in January, as retail investors who frequent Reddit message boards bid up some of the market’s most shorted shares. Nonetheless, the epic meltup in names like GameStop is tantalizing to short sellers.

“You’ve had a very unhealthy abandonment of discipline around valuation,” said Hampton Road Capital Management founder John Thaler, who oversees $250 million and weathered last month’s carnage, with a 5.1% return to start the year. “If something happens to pop the bubble, these investors will retreat and it will have a cascading effect -- with losses begetting more losses.”

Still, the frenzy of short-covering that wreaked havoc on the markets last week appears to be concentrated in just a few names and not a widespread trend. The average short interest in the 25 most bet-against members of the Russell 2000 was higher at the end of January than a year earlier.

Here’s where a few of last year’s big winners are putting their money this year, according to people familiar with the firms:

Eduardo Costa

Calixto Global Investors

Hedge Funds Hunt Frothy Names to Short, Even After GameStop

Focus: Global tech and consumer stocks, primarily small- and mid-caps.

AUM: $285 million

2020 Return: 47%

  • Owns a stake in Demae-Can, which controls a third of Japan’s food-delivery market.
  • Outsourcing Inc., a Japanese staffing firm, should benefit from a trend toward large corporations outsourcing some of their labor needs. Smaller players went bust during the worst of the pandemic.
  • Short themes include software, e-commerce, for-profit-education and mobile-gaming companies.

John Thaler

Hampton Road Capital Management

Focus: Global technology and consumer stocks

AUM: $250 million

2020 Return: 47%

  • Nexstar Media Group Inc., the largest owner of local TV broadcasters, is among the top picks. The stock is down almost 16% from last year’s high.
  • He’s now focused on shorting the basket of names being propped up by retail investors that have no underlying business or fundamental support.

David Steinberg and Eric Udoff

Marlowe Partners

Hedge Funds Hunt Frothy Names to Short, Even After GameStop

Focus: Equities and credit

AUM: About $280 million

2020 Return: 37%

  • CVS Group Plc, a London-based animal health company.
  • Fluidra SA, a Spanish builder of swimming pools, which is benefiting from a backlog for construction and maintenance.
  • Leisure hotels with open-air lobbies to capitalize on increased travel.
  • Callaway Golf Co. and other golf-related firms, as 2020 brought an influx of new players, and they expect that to continue.

Phil Hilal

Clearfield Capital Management

Hedge Funds Hunt Frothy Names to Short, Even After GameStop

Focus: Equities

AUM: $300 million

2020 Return: 21%

  • Biggest wager is on two European payments companies, Nexi SpA and Worldline SA, as the pandemic accelerated the long-term shift to electronic payments from cash.
  • Dufry, the Swiss operator of duty-free concessions, which has a joint venture with Alibaba Group Holding Ltd. that will bolster its presence in China.

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