Archegos Capital: The Death of a Beached Whale
Updated
What is a Whale, and Why is Archegos Capital One?
Archegos Capital is what's called a "whale," meaning it's a big enough hedge fund that it can drive prices higher all by itself. Since a lot of traders buy "momentum" stocks, whales can make money by manipulating prices higher and then selling to "dumb money" that buys momentum stocks without regard to fundamentals on the assumption that the stock's momentum is some kind of meaningful signal about the company's health.
Archegos seems to have been doing this for a while now, and it's been doing it largely with borrowed money. Archegos had about 500% more money in the market than it actually has in assets. (We call this 5x leverage.) This money was concentrated in just a few highly overvalued media and Chinese stocks-- ViacomCBS, Discovery Media, Baidu, Tencent, VIPshop, GSX, Farfetch, IQIYI, FUTU, and UP Fintech.
What is a Margin Call? How Archegos Got Beached
Lately, the winds have been shifting and traders have been abandoning overheated "momentum" stocks in favor of defensive value plays. Archegos has been feeling the pain. Then ViacomCBS-- one of Archegos's largest holdings-- announced that it would issue a bunch of new shares. This caused the stock price to drop. The sudden sharp reduction in Archegos's value put it over its borrowing limit and caused its lenders issue a "margin call," demanding that it sell shares to cover its debts.
Because Archegos's holdings were so concentrated, its selling triggered a chain reaction. The prices of its main holdings plummeted, causing more margin calls and more forced selling. As a result, Archegos Capital has lost some 33bn in the last 3-4 trading days. The unwind has been spectacular to watch. Its main holdings are down 15-50%. (Archegos also apparently had short positions in the S&P 500, which is why the S&P shot higher as the fund unwound those positions in the last hour of trading Friday.) Rumor has it that Archegos may still have some 20bn of positions left to unwind this week, including a couple billion in ViacomCBS.
Archegos CEO Bill Hwang is an evangelical Christian (trustee of Fuller Theological Seminary, among other things) who publicly attributes his investing success to his faith. He also pleaded guilty in 2012 to charges of insider trading. He reminds me a lot of ARK Invest CEO Cathie Wood, another whale fund leader who talks a lot about faith. I hope Cathie's investors are taking notes.
Along with the GameStop fiasco, this is the sort of activity you see at major market turning points. What has worked for years suddenly stops working. The tide goes out, leaving bad bets and price manipulation schemes exposed on the beach.
As the Momentum Tide Goes Out, Beware Leverage and Concentration Risk
The Archegos story dramatically illustrates two different points.
First, the market is losing faith in "momentum" as a technical signal, at least until prices correct quite a bit.
And second, leverage and concentration pose a significant market risk. Market crashes require forced selling, and forced selling requires leverage. Overall margin debt is now at an all-time high of $813 billion, according to FINRA data. That's up from $479 billion this time last year. That means that risk is high, and we could see more interesting margin call events if hedge funds fail to learn their lesson from this.
Archegos Capital is what's called a "whale," meaning it's a big enough hedge fund that it can drive prices higher all by itself. Since a lot of traders buy "momentum" stocks, whales can make money by manipulating prices higher and then selling to "dumb money" that buys momentum stocks without regard to fundamentals on the assumption that the stock's momentum is some kind of meaningful signal about the company's health.
Archegos seems to have been doing this for a while now, and it's been doing it largely with borrowed money. Archegos had about 500% more money in the market than it actually has in assets. (We call this 5x leverage.) This money was concentrated in just a few highly overvalued media and Chinese stocks-- ViacomCBS, Discovery Media, Baidu, Tencent, VIPshop, GSX, Farfetch, IQIYI, FUTU, and UP Fintech.
What is a Margin Call? How Archegos Got Beached
Lately, the winds have been shifting and traders have been abandoning overheated "momentum" stocks in favor of defensive value plays. Archegos has been feeling the pain. Then ViacomCBS-- one of Archegos's largest holdings-- announced that it would issue a bunch of new shares. This caused the stock price to drop. The sudden sharp reduction in Archegos's value put it over its borrowing limit and caused its lenders issue a "margin call," demanding that it sell shares to cover its debts.
Because Archegos's holdings were so concentrated, its selling triggered a chain reaction. The prices of its main holdings plummeted, causing more margin calls and more forced selling. As a result, Archegos Capital has lost some 33bn in the last 3-4 trading days. The unwind has been spectacular to watch. Its main holdings are down 15-50%. (Archegos also apparently had short positions in the S&P 500, which is why the S&P shot higher as the fund unwound those positions in the last hour of trading Friday.) Rumor has it that Archegos may still have some 20bn of positions left to unwind this week, including a couple billion in ViacomCBS.
Archegos CEO Bill Hwang is an evangelical Christian (trustee of Fuller Theological Seminary, among other things) who publicly attributes his investing success to his faith. He also pleaded guilty in 2012 to charges of insider trading. He reminds me a lot of ARK Invest CEO Cathie Wood, another whale fund leader who talks a lot about faith. I hope Cathie's investors are taking notes.
Along with the GameStop fiasco, this is the sort of activity you see at major market turning points. What has worked for years suddenly stops working. The tide goes out, leaving bad bets and price manipulation schemes exposed on the beach.
As the Momentum Tide Goes Out, Beware Leverage and Concentration Risk
The Archegos story dramatically illustrates two different points.
First, the market is losing faith in "momentum" as a technical signal, at least until prices correct quite a bit.
And second, leverage and concentration pose a significant market risk. Market crashes require forced selling, and forced selling requires leverage. Overall margin debt is now at an all-time high of $813 billion, according to FINRA data. That's up from $479 billion this time last year. That means that risk is high, and we could see more interesting margin call events if hedge funds fail to learn their lesson from this.
Note
The banks that lent Archegos all that leverage are hurting. Credit Suisse lost a sixth of its market cap, and Nomura and Deutsche are also hurting. Morgan Stanley and Goldman Sachs seem to have been the first to offload Archegos positions and thus came out okay. There was some talk among the banks of cooperating to stem losses, but at the end of the day, banking is a shark tank.Note
I got some objections in the comments to my comparison between Archegos and Ark. Ark isn't leveraged like Archegos, that's true. But with $53 billion under management, it doesn't need to be leveraged in order to drive prices all by itself. And Ark does seem to specialize in throwing its weight around. It's certainly a whale.I admit that anytime someone talks God and money in the same breath, my hackles get raised. That may be a prejudice on my part. I'm a historian of religion by training, and lately all my academic work has concerned religious frauds. I am perhaps overly attuned to the ways that religion gets abused.
But it's not just prejudice that makes me dislike Ark. Cathie used to go on CNBC to pump Tesla in the morning, and then in the afternoon ARKK would unload a bunch of Tesla shares. Ark buys a lot of overpriced stocks and issues a lot of incompetent analysis. They don't, in my opinion, act as responsible fiduciaries.
Note
Sources close to the Goldman Sachs trades have told reporters that Goldman came out totally unscathed and may even have profited from these trades. Apparently it pays to be the first mover on something like this. Reminds me a lot of the movie Margin Call. (The part about profiting from the trades is puzzling. I'm not sure how they could have profited unless they're front-running their customers' trades.)Note
It's also being reported this morning that Archegos provides the same collateral to several different banks in order to get more leverage.Note
The latest headline from CNBC: "Morgan Stanley dumped $5 billion in Archegos’ stocks the night before massive fire sale hit rivals"According to the article, "The bank offered the shares at a discount, telling the hedge funds that they were part of a margin call that could prevent the collapse of an unnamed client. But the investment bank had information it didn’t share with the stock buyers: The basket of shares it was selling was merely the opening salvo of an unprecedented wave of sales by Morgan Stanley and five other investment banks starting the very next day. Some of the clients felt betrayed by Morgan Stanley because they didn’t receive that crucial context, according to one of the people familiar with the trades. . . . 'I think it was an "oh s---" moment where Morgan was looking at potentially $10 billion in losses on their book alone, and they had to move risk fast,' the person with knowledge said."
Note
Big change in open interest on VIAC today, with interest heavily on the call side rather than the put side. Short-term put/call ratio at 0.55.
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