Thursday, October 30, 2008

Another strange incident... in a market full of anomalies!

In markets such as this one, where investors are reacting to events and rationality takes a back seat, we should not be surprised when we see anomalies... And that is where I would put what happened to Volkswagen's stock price this week. For a brief period on Tuesday, Volkswagen's market cap jumped four-fold to briefly become the largest market cap company in the world (in excess of $ 350 billion). In the process, hedge funds who had shorted the stock lost almost $ 20 billion. It was a classic "short squeeze", sometimes seen with small, market cap companies that are lightly traded, but seldom in a company of this size.
So, what happened? First, more than 60% of the shares in Volkswagen were held by investors who were not interested in selling the shares - 40%+ by Porsche and 20% by the Government of Lower Saxony; the float in the shares was low. Second, Porsche triggered the first run-up in the price by revealing that it would push its ownership stake to a higher number (60% or more). Third, the jump in the overall equity market on Tuesday added fuel to the price increase fire. Finally, the short positions that the hedge funds had were public information. Consequently, investors with net plus positions in the stock knew that they had the hedge funds over a barrel and could bargain for a higher price.
Today, the recriminations are flying. The hedge funds are accusing Porsche of misleading them, by leading them to believe that it would not increase its existing holding in VW. I think that Porsche did take advantage of these hedge funds and made billions in profits; in fact, it made more money from call options it had on Volkwagen stock last year than it made on it's entire auto business put together. At the same time, I feel not one iota of sympathy for the complaining hedge funds, since I am sure that they would have had absolutely no qualms doing exactly what Porsche did, if their roles had been reversed. You live by the sword, you die by the sword...


Mahesh Sethuraman said...

Hedge funds cryig foul....what a joke!

Wasn't it known in advance that German regulations are not so stringent about disclosure norms as US or UK is? So wasn't that an inherent risk in the short sell strategy?

Taking a naked bet especially on the downward move on a stock which is thinly traded in public, carries a huge risk - improbable may be but not impossible. There's more to markets than mere modeling, automated execution and stop losses even in normal times and all the more so in panic times.

Anonymous said...

Hi Prof,
Funny you did a story on that cause I have a same piece on my blog at

Anyhow,I did a quick calculation up to the 29th and estimated the loss to be about USD 17 billion. The basis was that all buying from
the 27th till the 29th was short covering, and the average short price was at 250 Euros.
However, as I blog Volkswagen is still trading at 543 euros, but the volume is significantly lower. My question is, when the short covering is done, will
a) there be a collapse in the share price?
b) will Porsche book this gain by selling of their investment
c) with a capital loss in the region of 20 - 30 billion USD, much greater than the capital of the hedge fund(s), will the prime broker have to foot the bill

Thanks, and to all readers who venture to padedoh, welcome there.
Wenger J Khairy

I'd like to be a sheep said...

Hi Prof... I found your blog from your site... I'm a really passionate value investor since 3 yrs (i'm 20 yrs old) and I just want to compliment and to thank you for all the materials, data and works available on your site...

Maybe when I'll finish the university here in Italy, I'll try to escape form this crazy country and meet you personally in NY..

Good WorK!