Depending on who you believe, Bill Hwang’s Archegos leveraged the $10bn in assets under management between five and 10 times, using money borrowed from bank to punt tech stocks. That means after the Archegos blowup, an exposure of between $50bn and $100bn exists, not all of it yet covered. Local hedge fund icon Cy Jacobs mentioned Spotify among Hwang’s punts, another reason why it was dropped yesterday from the BizNews Share portfolio. More relevant formost South Africans, though, is the emergence of Tencent as another of Hwang’s favourites – given the stock’s massive relevance to the JSE through 31% shareholder Naspers/Prosus. On a broader scale, the Archegos story has potential implications for all investors in an overheated US stock market. Here’s some excellent analysis from our partners at The Wall Street Journal. – Alec Hogg
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Archegos Gives Investors Warning Signs
Question is whether Archegos is just an accident on a lonely road or a pileup waiting to happen
March 30, 2021 1:03 pm ET
On the highway, the most dangerous moment is when everything is calm and the outlook is great, because that’s when you put on the cruise control, turn up the music and miss the lumbering RV pulling out of a rest stop.
It is the same in the markets. Booming stocks and fabulous returns soothed the worries of risk departments, leaving some banks nursing multibillion-dollar losses when the concentrated bets of Archegos Capital Management went from 90 mph to an emergency stop.
The question for the rest of us is whether Archegos is just an accident on a lonely road or a pileup waiting to happen. I think it is probably a one-off, but the problems that walloped Archegos could force others to hit the brakes, too. There are four dangerous elements:
* Leverage. As always, too much debt is at the heart of any blowup. Leverage turns millionaires into billionaires, and billionaires into paupers. And there is a lot of debt around: Credit to the U.S. private sector has passed 160% of GDP for the first time since its brief rise above that around the global financial crisis in 2008, according to the Bank for International Settlements.
The more debt there is, the smaller a hit borrowers can take before running into trouble. The good news for the economy is that household borrowing hasn’t picked up much, as government handouts and a lack of spending opportunities boosted savings.
The bad news is that corporate debt reached a new high of 84% of GDP last summer, which crimps the ability of companies to withstand any new shock to the economy or their ability to refinance.
These figures don’t include hedge funds, though. Hedge-fund borrowing reached a new peak in January, according to Goldman Sachs, which prefigured a brief period of poor returns for funds as they were hit by short squeezes such as GameStop Corp. GME 7.26% and cut back leverage.
I’m pretty sanguine about the prospects of deleveraging hurting investors more widely. In part, this is because the markets overall sailed through even as hedge funds cut back debt this year. Since the January high, gross leverage—which combines bets both on rising and falling prices—among Goldman prime brokerage clients has dropped to 242% from 260%, while the S&P 500 reached new highs.
But we have to accept that when a firm few have heard of turns out to have taken some insane risks enabled by banks that didn’t probe deeply enough, the road ahead might have more such sinkholes.
* Elevated prices. One might think high stock prices—and they are high!—is a good thing. But lenders relax their guard in good times and tighten in bad times, so falls from those highs have the added pain of less lending.
Fund blowups become a problem for markets either when there are a lot of them all at once, as in 2008, or they are so big they threaten to bring down banks, as with Long-Term Capital Management in 1998. The only way to get a lot at once is when many hedge funds (and similar vehicles such as Archegos) are crowding into the same strategies and taken out by the same unexpected market moves.
We have to hope that banks haven’t been dumb enough to allow lots of others to borrow so much for such concentrated trades as Archegos, which appears to have eschewed risk management for bets on a handful of Chinese stocks and U.S. media groups ViacomCBS Inc. VIAC 3.55% and Discovery Inc. DISCB 28.93%
Isolated fund blowups are exciting, but they are a spectator sport for the rest of us. The risk at the moment is that hedge funds are united in their bets in two areas: inflation and speculative technology stocks.
* Crowded positions. There is strong unanimity across markets about the reflation trade, which involves betting on rising Treasury yields and stocks which benefit from a booming economy, and against the safe stocks that won amid last year’s economic weakness. If something goes wrong, many people will be caught out. Some will surely, in the words of Warren Buffett, have been swimming naked, with far too much debt on what seemed like a sure bet.
