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 lent it money to buy shares were scrambling to offload Archegos' investments after a handful of risky bets made by the hedge fund went bad. The rush to exit these positions hit public shares prices, leaving banks with huge losses.
Hedge funds typically borrow money from banks to invest, a process known as margin trading. This allows funds to leverage up the cash they hold and increase their positions — potentially earning far greater returns if their bets come good. However, it also means hedge funds can theoretically lose more money than they hold in client funds.
If trades made on margin turn sour, banks will ask a client to put up more money as collateral to limit potential losses. This process is known as a margin call.
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Archegos faced margin calls on its positions last week but failed to provide extra cash. As a result, banks began selling off stocks held on the hedge fund's behalf — a fire sale known in the City as liquidating positions. The business press reported on Friday that Goldman Sachs (GS) and Morgan Stanley (MS) were selling huge chunks of shares in businesses including ViacomCBS (VIAC), Discovery (DISCA) and Chinese stocks Baidu (BIDU) and Tencent Music (TME). The block sales are estimated to be worth around $20bn (£14.5bn), according to the Financial Times.
"Things started going wrong for Archegos when shares of companies such as Viacom started to slide mid-last week," said Michael Brown, a senior market analyst at Caxton Business. "It was at that point that margins were called, and couldn’t be provided, hence the block sales seen Friday."
A fire sale can have a negative impact on stock prices and shares in both ViacomCBS and Discovery sunk 27% on Friday. Banks therefore risked making less back from the sales than they lent to clients to fund the investments.
Credit Suisse on Monday warned it was facing "highly significant" losses linked to Archegos that could be "material to our first quarter results".
The Swiss lender didn't name Archegos but said: "A significant US-based hedge fund 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 held by Archegos. The bank said it was "premature" to estimate how much it would likely lose from the crisis.
"We intend to provide an update on this matter in due course," Credit Suisse said.
Shares sunk 13.4% in Zurich.
Japanese bank Nomura said it too was facing "a significant loss arising from transactions with a US client." The bank said it was "currently evaluating the extent of the possible loss" but said it was trying to claw back $2bn from Archegos.
Shares in Nomura sunk over 16% in Tokyo.
Deutsche Bank reportedly also did business with Archegos. A source at the bank said its exposure was "fraction" of that of other lenders. A spokesperson declined to comment. Shares were 3.2% lower in Frankfurt.
Traders and investors were scrambling to try and figure out how far Archegos' exposure went and how bad the damage may be elsewhere. The iShares Euro Stoxx Bank 30 (EXX1.DE) fell 1.5% in early trade.
"Market sources estimate the fund was worth $10-15bn and running 5x leverage, which would set its holdings at approximately US$50-70bn," said Ben Onatibia, a senior strategist at Vanda Research.
Goldman and Morgan Stanley — which were behind Friday's block shares — have yet to publicly comment on the matter. Both have been contacted for comment. Shares in Goldman Sachs (GS) were down 1.9% in the pre-market in New York while Morgan Stanley (MS) was down 3%.
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Archegos is one of a number of so-called "Tiger Cub" funds — hedge funds set up by former employees of legendary US hedge fund Tiger Management. It was set up by Bill Hwang, a Tiger veteran who was convicted of insider trading by the SEC in 2012.
Archegos is Hwang's family office, meaning it manages his money and does not accept outside capital. The fund specialises in "public equities 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. Archegos' public website was offline on Monday morning.
"One would assume that, judging by the size of positions sold, the ‘game is up’ for Archegos," Brown said.
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."
A hedge fund blow up is relatively unusual and Archegos' undoing has raised concerns that other funds could find themselves in similar positions.
"Block equity-trades stemming from margin-calls on Archegos will have sent the market’s spidey senses a tingle," said Bill Blain, a senior strategist at Shard Capital. "Who is next?"
Alex Harvey, a portfolio manager at Momentum, said: "We tend to find out after the event that other funds get caught up as sometimes hedge funds may be crowded into similar trades."
Wilson said increased market volatility in particular stocks raised questions about whether these sorts of leveraged blowups could become more common.
"When we look at this and think about the GameStop saga and the decline in Tesla as two examples — what we're seeing are more and more pockets of very unusual trading activity in some stocks," he said. "You worry that this sort of frothy trading activity in turn creates pockets of distress among investors and banks that leads to larger unwinds and losses for financials."
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