Deep Basin Fund Returns Capital Citing ‘Dangerous’ Market

(Bloomberg) -- Energy hedge fund Deep Basin Capital LP is returning capital to investors after retail traders drove market volatility to extreme levels, hitting some of the fund’s positions, according a letter to investors reviewed by Bloomberg News.

“I do not believe that risk markets are functioning properly and am deeply concerned about the immediate investment climate,” Matthew J. Smith, managing partner of the Stamford, Connecticut-based fund, wrote in the letter.

“Further, the market structure has changed and become more dangerous in ways that at this point are difficult to quantify and understand, and I cannot fully study these changes while taking risk with partner capital,” he wrote.

The fund fell 1% in 2020 and another 2.7% in the first two months of this year, according to a person familiar with its performance.

“Long before the Gamestop fiasco raised broad awareness of the impact of retail investors on the stock market, we witnessed an escalating retail presence and extreme behavior in energy stocks starting in April 2020,” Smith wrote.

“Since then, and with increased regularity, we have seen volumes associated with retail flows exceed 50% of the daily trading in equities and equity options in a growing number of our stocks”

Hedge funds have struggled to make money for much of the last decade as equity markets surged, and there have been more hedge funds closures than launches since 2014, according to Hedge Fund Research. During the first three quarters of 2020, 619 funds shut compared with 364 that opened.

Melvin, Maplelane

Stock rallies driven by retail investors caused even greater pain for some short sellers this year, with funds like Melvin Capital Management and Maplelane Capital losing billions during January’s GameStop Corp. short squeeze. Melvin made up for some of its losses after gaining 22% in February.

A spokesperson for Deep Basin declined to comment.

Deep Basin counted among its holdings put options on retail trader darlings like Plug Power Inc. and Tesla Inc., according to the fund’s fourth-quarter disclosure. Armed with cash, retail traders crowded into obscure companies like Ring Energy, sending call-option volume soaring for the tiny producer.

‘Tectonic Shift’

Smith cited a shift in the market’s ability to tolerate short selling as one reason for liquidating the fund, writing that in recent weeks “we have witnessed a tectonic shift in the market’s ability to short anything.” Agencies that are tasked with regulating the market have also turned it into “a levered casino.”

The majority of partners’ capital should be returned by mid-April, and while most of the fund’s risk has been reduced, it remains 20% gross exposed and will be reduced passively during March.

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