Since last Friday, a total of $20 billion stock sale of select US and Chinese companies was reported. The market is wary on what is yet to unfold since a lot of things still remain ambiguous. Eager to know how a family run investment firm called Archegos Capital Management caused such chaos without a single red flag being raised beforehand? Read our story to find out.
Crux of the Matter
What’s this Archegos Capital that is revamping Lehman Movement at Wall Street?
It’s a ‘family run’ private investment firm managed by Bill Hwang. A former equity analyst with Tiger Management, he also ran Tiger Asia until 2012, where he along with his firm was charged with $44 mn for insider trading. Post the scrutiny, he turned Tiger Asia into the present day Archegos.
Well, Hwang’s background is too far from being straight. But what did they do to cause this Wall Street Carnage?
They entered into a swap transaction with different financial institutions (FIs).
Wait, what’s a swap transaction?
It’s a transaction in which two parties swap their returns. For instance:
You want return on gold and I on stocks, but you own only stocks, and I gold. In that case, we can enter into an agreement wherein you give me returns on stocks and in exchange get return on gold.
Is that what Archegos also did?
Yes. It offered its brokers (FIs) fixed fee/ interest rate in return of exposure to the firm’s equity portfolio.
Oh, that also means they did not own any of the stocks they earned return on, right?
Precisely. In market lingo, that’s also called using leverage.
So where did things go wrong?
Problems started when the stock price of many of the stocks in which Archegos had large positions, started falling
Why is it a problem?
Equity portfolio’s value dropped to such an extent that Archegos’ regular fee payment couldn’t cover the losses. Then they were asked to pay more money or put something for collateral. This is called Margin Call in the markets.
Were they able to pay that amount?
No. That’s when things got worse. All the FIs that actually owned the stocks, started selling those stocks because Archegos was unable to pay. Morgan Stanley and Goldman Sachs combined sold ~$20 bn worth of equities. Look at these crazy losses
That’s a huge number.
Main lessons that people are drawing
a. Limiting the use of leverage: They had only $10 bn in assets but had exposure to positions worth ~$40 bn using leverage! Not to forget the sloppy credit worthiness of Bill Hwang.
b. Regulation Purview: The hedge fund transactions carried out by family run firms are not covered under the SEC purview, which makes them more prone to default and riskier.
Indeed, what a crazy world of finance!
- The Tiger Cubs are a group of former Tiger Management employees who have since founded their own Hedge Funds. Bill Hwang is one of the ‘Cubs’. In addition, Hedge Funds that Tiger Management founder, Julian Robertson has invested in are known as “Tiger Seeds“.
- In finance, margin is the collateral that a holder of a financial instrument has to deposit with a counterparty to cover some or all of the credit risk the holder poses for the counterparty. The collateral for a margin account can be the cash deposited in the account or securities provided, and represents the funds available to the account holder for further share trading
- The Standard Portfolio Analysis of Risk, or SPAN, is a system for calculating margin requirements for futures and options on futures. It was developed by the Chicago Mercantile Exchange in 1988.