A little-known hedge fund that blew up last week has sent shockwaves through the world of investment banking.
Banks that worked with Archegos and borrowed the money to buy shares tried to offload Archegos’ investments after a handful of risky hedge fund bets failed. The rush to leave these positions hit stock market prices, causing huge losses for banks.
Hedge funds typically borrow money from banks to invest, a process known as margin trading. This allows funds to take advantage of the money they have and increase their holdings, potentially allowing them to get a lot more returns if their bets are good. However, it also means that, in theory, hedge funds can lose more money than they hold in client funds.
If transactions on margin turn sour, banks will ask a customer to deposit more money as collateral to mitigate potential losses. This process is known as a margin call.
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Archegos experienced margin calls on its positions last week, but did not bring in additional cash. As a result, banks began to sell shares held on behalf of the hedge fund – a fire sale known in the city as liquidating positions. The corporate press reported on Friday that Goldman Sachs (GS) and Morgan Stanley (MRS) sold massive amounts of shares in companies, including ViacomCBS (VIAC), Discovery (DISCA) and Chinese stocks of Baidu (BIDU) and Tencent Music (TME). The block sales are estimated to be around $ 20 billion (£ 14.5 billion), according to the Financial Times.
“Things went wrong for Archegos when shares of companies such as Viacom started to decline mid-way through last week,” said Michael Brown, a senior market analyst at Caxton Business. “It was then that the margins were called and could not be provided, hence the block sales we saw on Friday.”
A fire sale could negatively impact stock prices, and both ViacomCBS and Discovery shares fell 27% on Friday. Banks therefore risked recouping less from the sales than they lent to customers to finance the investments.
Credit Suisse warned Monday that it was dealing with “very significant” losses related to Archegos, which “could be material to our first quarter results.”
The Swiss lender did not mention Archegos, but said, “A major US hedge fund has defaulted on margin calls made last week by Credit Suisse and certain other banks.”
Credit Suisse said it was “in the process” of selling shares owned by Archegos. The bank said it was “premature” to estimate how much it was likely to lose as a result of the crisis.
“We plan to provide an update on this issue in due course,” said Credit Suisse.
In Zurich, shares fell by 13.4%.
Japanese bank Nomura said it also had to do with “a significant loss from transactions with a US customer.” The bank said it was “currently evaluating the magnitude of the potential loss,” but said it was trying to recover $ 2 billion from Archegos.
Shares in Nomura fell more than 16% in Tokyo.
Deutsche Bank also reportedly did business with Archegos. A source at the bank said the exposure was “a fraction” of that of other lenders. A spokesman declined to comment. Stocks in Frankfurt were 3.2% lower.
Traders and investors tried to figure out how far Archegos’ exposure went and how bad the damage could be elsewhere. The iShares Euro Stoxx Bank 30 (EXX1.DE) fell 1.5% in early trading.
“Market sources estimate that the fund was worth $ 10-15 billion and would have leverage of 5x, bringing its positions to approximately $ 50-70 billion,” said Ben Onatibia, a senior strategist at Vanda Research.
Goldman and Morgan Stanley – who were behind Friday’s block shares – have yet to publicly comment on the matter. Both have been approached for comment. Shares in Goldman Sachs (GS) fell 1.9% in pre-market in New York, while Morgan Stanley (MRS) decreased by 3%.
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Archegos is one of the so-called “Tiger Cub” funds – hedge funds created by former employees of the legendary US hedge fund Tiger Management. It was set up by Bill Hwang, a Tiger veteran who was convicted by the SEC in 2012 for insider trading.
Archegos is Hwang’s family office, which means it manages its money and does not accept outside capital. The fund specializes in “public stocks, primarily in the United States, China, Japan and Korea” and takes a “multi-year approach to investing”. according to LinkedIn. The fund takes its name from the Greek word for author or captain. The Archegos public website was offline on Monday morning.
“You would assume that judging by the size of the positions sold, the ‘game is over’ for Archegos,” said Brown.
He said it was “unlikely” that Archegos would pose a systemic risk to the financial system. Neil Wilson, chief market analyst at Markets.com, said the hedge fund “appears to have been too concentrated in a number of risky stocks.”
Blowing up a hedge fund is relatively uncommon and Archegos’ undoing has raised concerns that other funds could be in similar positions.
“Blocking stock transactions as a result of margin calls on Archegos will have tingled the keen senses of the market,” said Bill Blain, a senior strategist at Shard Capital. “Who’s next?”
Alex Harvey, a portfolio manager at Momentum, said, “We tend to find out afterwards that other funds are trapped as hedge funds sometimes get into similar trades.”
Wilson said the increased market volatility in certain stocks raised the question of whether such leverage could be more common.
“If we look at this and think about the GameStop saga and Tesla’s decline as two examples – what we’re seeing are more and more pockets of very unusual trading activity in some stocks,” he said. “You are concerned that this kind of frothy trading activity is in turn creating turmoil among investors and banks, leading to increased settlements and losses for financial institutions.”
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