Melvin Capital, now a defunct hedge fund, was heavily reliant on shorting strategies. They worked on finding overvalued stocks and bet that they would fall. That approach is generally risky, especially in periods of market high volatility. One of the proponents of their failure was the infamous GameStop short squeeze in 2021. To better understand all the reasons for their demise, we need to conduct Melvin Capital Portfolio Analysis.
After the GameStop failure, Melvin Capital managed to diversify its portfolio into several sectors. If handled properly they could try to pull out of the bad spot they fell into, but subsequent shorting misses didn’t help and there was no other way but to close the fund.
In their last 13F filing Melvin Capital had a portfolio focused on Customer Discretionary and Technology sectors. Other major investment sectors were the Telecommunication industry and healthcare. To better understand the story behind Melvin Capital, and their downfall, stay with us.
Sector Allocation
Sector allocation according to the last 13F filing was:
- Consumer Discretionary with 41.29% of the portfolio
- Technology with 29.22% of the portfolio
- Communications with 12.4% of the portfolio
- Healthcare with 5.09% of the portfolio
- Finance with 3.38% of the portfolio
- Industrials with 3.13% of the portfolio
- Materials with 2.79% of the portfolio
- Consumer Staples with 2.7% of the portfolio.
Overview of Melvin Capital
Melvin Capital Management was founded in 2014 by Gabriel Plotkin. He gathered almost a decade of investing experience in S.A.C. Capital Advisors under Steve Cohen before he founded his company. Cohen gave him $200 million as a starting investment.
Fund’s investment strategy was focused on long-short equity while they paid special attention to concentrated value investing. Plotkin and his team of analysts invested in both short and long-term stocks. They wanted to generate alpha by carefully choosing of stocks and trying to time the trades to generate the highest returns.
Although the fund generally delivered high returns, problems started with GameStop. Plotkin owned their stocks since 2014 and he was sure that their price would fall. But, the opposite happened and Plotkin needed to buy back shares at much higher prices so he could cover his short position, leading to massive losses.
The problems didn’t stop there. Funds preferred a shorting approach which didn’t give good enough results, especially after the failure with GameStop. The fund continued to struggle and investors started to lose confidence in the fund’s leadership and strategy.
Plotkin struggled not only to attract new investors but also to keep the existing ones. This manifested in a lack of capital to invest, and in May 2023 Plotkin decided to close the fund.
Melvin Capital Portfolio Performance
Historical Performance
Melvin Capital Management LP produced above-average returns in the period between 2014 and 2020, managing to generate over 30% annual returns. In 2015 they accomplished a rare feat generating a return of 47%. This put them in second place on Bloomberg’s list for 2015 for the most successful hedge funds with AUM over $1 billion.
There were other highly successful years like 2019 with 47% returns and 2020 with 51% returns. But, the problem started in 2021 when at the beginning of the year several shorting stints including GameStop went the wrong way ending with a loss of 30%.
What Led To Their Closure?
Several users on Reddit shared a rumor that the GameStop stock price will rise. The community wanted to challenge Wall Street and also wanted to see if GameStop would be able to make a turnaround.
This triggered a massive influx of retail investors that fueled the demand for GameStop stocks. The price of their stocks skyrocketed triggering a short squeeze for Melvin Capital and other short sellers. Melvin owned a solid chunk of their stocks, which triggered massive losses.
They needed to cover their short position and were left with a loss of over $7 billion. To cover this, Melvin Capital looked for support left and right, and even from several hedge funds. Steve Cohen jumped in with $750 million, and Ken Griffin invested a total of $2 billion to stabilize the fund.
But that was only the start of Melvin Capital’s problems. After this massive blow, the investors lost confidence in the fund’s management triggering demands for redemption. High market volatility didn’t help the fund, which caused other short positions to generate losses.
When all these problems piled up, the investors decided to pull out. They lost all respect and trust in the fund executives. And when there is no capital to invest, the only thing you can do is to close up shop.
Melvin Capital Portfolio Strategies
Melvin Capital used a long-short equity strategy. This means that they betted short on stocks that they were relieved that they would go down, and long in case of an expected rise. To successfully manage this strategy Melvin Capital employed a team of dedicated analysts. They were focused on analyzing companies, their fundamentals, and market trends. In case they found companies with underlying issues, like debt, bad management, or not enough edge, but overpriced, they would bet against them.
The other approach was to find successful but not enough appreciated companies that have a chance in the long term. Then they will buy them cheap and wait for them to reach their full potential. There were cases when they even entered event-driven investments, like mergers and acquisitions to capitalize on price fluctuations in that process. Melvin Capital kept a concentrated portfolio between 30 and 50 holdings diversified in different industry sectors to mitigate risk.
FAQs
Who Invested in Melvin Capital?
Gabriel Plotkin’s mentor was Steve Cohen, and he was the first to offer him seed money to start his hedge fund. His investment of $200 million allowed Plotkin to start relatively easily and to attract other investors.
How Much Did Melvin Capital Lose on Game Stop?
From available reports, Melvin Capital lost at least $7 billion on a GameStop short.
Why Did Melvin Capital Shut Down?
The combination of factors caused Malvin Capital to shut down. It all started with a GameStop shorting failure. It ensured other investments failed, and the majority of investors lost their trust in the fund. On the other hand, the fund couldn’t gather enough fresh capital which eventually led them out of business.
Final Thoughts
Melvin Capital is a story of a failure due to circumstances that are hard to imagine and predict. Once a highly successful fund, after a series of events mostly out of their reach crumbled before our eyes.
Gabriel Plotkin, who has a very diverse and long investing experience, decided to stay in the investment sector. He did close his first fund, but he founded Tallwoods Capital LLC, a family office. Plotkin decided to change his approach and focus on long-term investments in different asset classes including public equity, private equity, and real estate.
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