The Archegos Fallout: Risk-taking on another level
Behind all curtains, stands the culprit who stripped several companies off of $20 billion dollars four months ago. How could one fund run by one of the most religious general managers cause such an enormous fallout? Well, before breaking the ice, let me answer the first question: Who is in the center of this disaster? Although he was known to only his church and board members, Bill Hwang was no stranger to his former colleagues. Before the Archegos Fallout, Bill Hwang was the captain of another sunken ship, by the name of Tiger Asia Management. He worked there as the general manager and turned in an investment of $1.2 billion dollars into a whopping $5 billion dollars. But wait, how did he manage to secure such huge investments in the first place?
It turns out, Bill Hwang was under the mentorship of Julian Robertson, who was already at the peak of his hedge fund career. Hwang’s performance at the fund impressed Julian and urged him to fund his company. This was a turning point for Hwang, as he finally got the opportunity and the necessary funding to launch his first fund, which was based on investing in Asian markets. Unfortunately, however, Tiger Asia was later studied by the SEC and was charged with handling confidential information, which resulted in a $44 million dollar fine! Despite giving birth to his first fallout (a miniature one), investors still saw the immense potential in him and funded yet another company that he created; Archegos Capital Management.
Archegos: An overview
Bill Hwang is extremely knowledgeable, and you easily see it right where he started. If you didn’t know, Bill Hwang’s Archegos is a family fund, which (lawfully) doesn’t adhere to the ‘buying on margin’ law made by the Federal Reserve.
Investopedia sheds light on the same, by stating that:
The Federal Reserve Board sets the margins securities. As of 2019, the board requires an investor to fund at least 50% of a security’s purchase price with cash. The investor may borrow the remaining 50% from a broker or a dealer.
They further go along to mention that:
Essentially, buying on margin implies that an individual is investing with borrowed money. Although there are benefits, the practice is thus risky for the investor with limited funds.
What Investopedia states on its website are straight-up facts. And this is exactly what Achegos didn’t take into account.
Instead of diversifying his portfolios and keeping investments open to his investors, Hwang did the exact opposite. Essentially, Hwang invested in a handful of companies (Discovery, ViacomCBS and Baidu) with the help of his analysts and poured most of his capital into them, while still using more than 70% leverage! Eliminating such risk is the job of risk analysts, from whom he kept his major investments secret. Another risk Hwang willingly took, was misusing Total Return Swaps.
Our friends over at Risk.com have explained it beautifully by saying that:
A total return swap is a derivative contract where one counterparty pays sums based on a floating interest rate, for example Libor plus a given spread, and receives payments based on the return of a reference asset such as a bond, stock or equity index. The returns include any gains or losses in the reference asset’s price as well as any relevant coupon or dividends over the period.
This allowed Bill Hwang to profit from assets that he didn’t even own, at the expense of paying off the losses that came with them.
Everything came crashing down:
Why should you know all of this? After all, it’s just his fund’s money at the end of the day, right? Wrong! His stakeholders and creditors were major banks like Credit Suisse, Goldman Sachs, Wells Fargo, Morgan Stanley, Deutsche Bank, UBS, Nemura! All of them had lost fortunes. Nemura had $2.87 billion, Credit Suisse a whopping $5.5 billion and Morgan Stanley $911 million in pure losses, all due to the failure of Archegos! The problem was that ViaCOM CBS’s share price dipped to half and Archegos had invested $10 billion dollars in the company.
Additionally, each bank had a huge share in Archegos, and if even one of them sold their position due to the drop, the share price would come tumbling down. And let me tell you, this is exactly what happened! All this while, Hwang was building a skyscraper with playing cards. One by one, each bank withdrew and Archegos retaliated by selling its other shares, but it was too late! On the other hand, these shares were the collateral that they had promised the banks, in case they faced a loss in the future. Therefore, when banks started asking for collateral at the end, Hwang had nothing to show them and thus, leading to disaster.
Despite this major setback, Bill Hwang has no intentions to stop, and still has huge goals set for Archegos, although now, he doesn’t have the support of new investors anymore, especially after George Soros sold his shares of Archegos that he bought during the disaster, just yesterday.