Muddy Waters Capital’s assets rose 40 percent in 2022, based largely on a fund it launched in February of 2021 that takes a longer-term view of its short positions using a proprietary artificial intelligence tool.
It’s unclear how much of the increase came from performance, but it appears that CEO Carson Block was able to raise assets for the fund last year despite the investigative cloud hanging over him and his hedge fund.
While still small, the Domino Fund ended the year with $104.6 million in regulatory assets under management, compared with $44 million at the end of 2021, according to the latest ADV filing with the Securities and Exchange Commission. It had 37 beneficial owners at yearend, compared with 26 at the end of 2021. Some 12 percent of the fund was owned by Muddy Waters, 42 percent was held by fund of funds, and 31 percent came from non-U.S. investors. Non-U.S. investors increased the most, more than doubling their stake in the fund.
Institutional Investor previously reported on the Domino fund in a profile of Block in April of 2021. At that time, Domino was running primarily with partner capital because its anchor investor — who was also an investor in Melvin Capital — pulled out when Melvin’s battle with GameStop investors caused it to lose more than 50 percent early that year.
“We were set to launch with probably ~$70 million,” Block said in a letter to investors in August of 2021. “But then GME and Melvin Capital happened. This carnage spooked some investors, and we launched with much less, and are presently at approximately $30 million in commitments.” He explained that Domino uses a draw structure.
Block said the Domino fund takes its name from an analogy he uses to describe short activism. “It’s a ‘power game’ … in which you knock down as many dominos as possible at the outset. Successful short activism relies on an occurrence of a sequence of metaphorical dominos falling, such as auditor changes, director resignations, or managerial unwillingness to act as aggressively, in order to generate ‘wins,’” he said.
But companies subject to short activist campaigns “tend to manage their information dissemination far more carefully than before the campaign,” Block said. “In a world in which the market playing field is angled sharply in favor of charlatans, I have not felt confident that I can tell with ‘the naked eye’ when a management is going to pull a rabbit out of the hat, and jam up the share price over the long-term, versus when the gig is up.”
That reality created a “timing problem” for short activists, he explained. “When should we cover? If we hold on too long, we can see the fruits of months of hard work (possibly followed by years of litigation) erased. I’ve been able to survive 11 years as a short activist by always being willing to close too early, versus too late.”
Block views his penchant for closing a substantial portion of his short positions soon after releasing a report as a form of risk management — but the practice has been controversial. While it is not illegal, according to securities lawyers, the practice still is believed to be one of the aspects of Muddy Waters’ business that both the SEC and the Department of Justice have looked at in their investigation. Their probe, which has been going on for more than a year and a half and has produced reams of documents from Muddy Waters, has not yet appeared to bear fruit. As II previously reported, two of the original prosecutors have left the DOJ, with one of them going to a law firm, Lathan & Watkins, that once represented the CEO of one of Block’s short targets.
Yet the short-term strategy hasn’t always been the best way to make money. Block explained in the 2021 letter — which was released before he knew he was under investigation — that closing positions early meant “that we’ve left real money on the table over the years.”
As a result, he said that in early 2019 Muddy Waters began to develop a fund that would avoid the “too early problem” by using AI to advise on when to close positions. “Working with a team of data scientists, we readied the AI by the end of 2019” and dubbed it ‘LANA.’
