Archegos Capital: The Death of a Beached WhaleWhat 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.
