by Diana R. Baechle, PhD
The recent euphoric trading of GameStop and other high-flying stocks—prompted by retail traders trying to squeeze institutional short sellers out of their positions—had a substantial impact on specific risk, particularly on less diversified portfolios, but even large benchmarks such as the Russell 2000 have been affected.
The frenzy produced large dislocations in equity-portfolio active risk. That said, the GameStop saga does not seem to be a “black swan” event. Rather it appears that retail investors have discovered the Achilles’ heel of hedge funds, as the retail-driven trading wave continues. The stocks now riding the wave could either be lifted by these momentum buys, change their fundamentals, and ultimately become success stories, or they could collapse once the hype is over. Either way, they will keep risk managers on their toes.
The videogame retailer GameStop (GME) has been at the center of a battleground between individual investors, whose buying pressure drove the stock up, and hedge funds, who were forced to buy back shares they sold short, pushing the stock even higher. GameStop’s stock price surged 18-fold from $18.84 on Dec. 31 to $347.51 on Jan. 27, while the 20-day average daily trading volume in GameStop rose above 5 billion on Wednesday, roughly 10 times the average trading volume of the typical Russell 2000 stock. GameStop shares slumped the next day, as several brokerages restricted the stock trading, but the videogame retailer was up again on Friday.
The GameStop story also ignited frenzied trading in other heavily shorted cast-off stocks, including the struggling home-goods retailer Bed Bath & Beyond, the nearly forgotten software and services firm BlackBerry, and the lockdown-struck AMC Entertainment, to name a few. In this study, we focus on GameStop and Bed Bath & Beyond (BBBY), both belonging to the Specialty Retail industry within the GICS sector Consumer Discretionary of the Russell 2000 index.
Stock Returns and Specific Risk
GME shares began to take off on Jan. 11, driving up its specific risk 60% in three days, its specific risk reaching 200% by Jan. 27. BBBY saw a more progressive rise in its price this year, and so did its specific risk—until Jan. 25 when the home-goods retailer’s shares jumped 70% from Jan. 25 to Jan 27, driving up its specific risk, which is now close to double the level on Dec. 31.
GME was up 1,745%, while BBBY rose 200%, for 2021 through Jan. 27. The two companies pushed up Specialty Retail by 33%, for a total gain of 49% for the industry over the same period. GME and BBBY contributed 7 percentage points to the 18% return of Consumer Discretionary. In contrast, the Russell 2000 index was up much less, a relatively modest 7%, with GME and BBBY being responsible for 1 percentage point of the benchmark gain, while the other 1,998 stocks contributed 6 percentage points.
GME and BBBY Weight in Specialty Retail
GME represented only about 1% of Specialty Retail last year—its weight ranking in the 30s among the 50 stocks in the industry. GameStop’s weight in the industry surged in 2021, and by Jan 27. it was the biggest, representing more than 20% of the entire industry.
The rise in BBBY’s price turned it into the fourth largest stock in Specialty Retail, accounting for 6% of the industry on Jan. 27. BBBY’s weight in Specialty Retail was higher than that of GME last year, but on Jan. 25 GME’s weight surpassed that of BBBY.
Industry, Sector, and Benchmark Specific Risk
Specific risk skyrocketed not only for GME and BBBY but also for their industry and sector, where risk is now at levels far above those seen during the global financial crisis. Specialty Retail’s specific risk more than quadrupled in 2021, reaching 44% on Jan.27, far above its 5% median over the past 14 years. Specific risk more than doubled for Consumer Discretionary since Dec. 31, and its level of 12% on Jan.27 was five times higher than its 2% median. Even the specific risk of the highly diversified Russell 2000 index ticked up and is now more than twice its 1% median.
Looking at the historical levels of the Russell 2000’s stock-specific risk going back to the inception of our US Small Cap model in 1982, we see that the index’s specific risk is now at levels not seen since the “dot-com bubble” two decades ago, as measured by Axioma’s US Small Cap short-horizon fundamental model. While specific risk is only a small part of total benchmark risk, it is likely to figure far more prominently in actively managed portfolios.
GME was responsible for 95% of the current level of specific risk for Specialty Retail, 80% of that of Consumer Discretionary and close to 40% of that of the Russell 2000. In contrast, BBBY had a relatively small contribution to the specific risk of the three groupings. Note that other high-flying stocks most certainly contributed to the Russell 2000’s specific risk.
Total Predicted Risk
GME’s total predicted risk rose 76% from Jan. 11 to Jan. 27, while that of Specialty Retail—now dominated by GME—saw a spike of close to 75% during the same period, indicating that the head-spinning volatility of GME could not be diversified away at the industry level. Consumer Discretionary’s total risk ticked up only slightly over the 11 business days, rising from 30% to 32%. The Russell 2000’s risk was relatively flat over the same period—a clear indication of the diversification power of the index.
Active Predicted Risk
The active risk of Consumer Discretionary vs. the Russell 2000 climbed this year, but it has not reached historic highs. In contrast, we have not seen this level of active risk for Specialty Retail in at least 14 years.
