Understanding the Archegos Collapse: 3 Key Takeaways from VAR Capital

In a tale that echoes the classic warnings of Greek mythology, there once lived a trader dubbed the “greatest of whales.” His venture, a family office launched in 2012 with a modest sum of approximately $200 million, flourished beyond imagination, amassing wealth that soared to over $10 billion. This trader rode the waves of success, navigating the financial oceans with enviable prowess. Yet, in a twist of fate, his journey was marred by the ancient flaws of hubris and excessive leverage, leading to a dramatic downfall. Ignoring the perilous undercurrents of risk led to the loss of his vast fortune.

This story is not a fable from antiquity but the real-life saga of Bill Hwang and his New York-based family office, Archegos Capital Management.

What Led to the Downfall of Archegos?

Bill Hwang’s Archegos Capital Management, founded in 2012 with about $200 million, witnessed meteoric growth to surpass $10 billion, buoyed by astute early investments in technology stalwarts like Amazon, LinkedIn, Netflix, and Expedia Group. This upward trajectory continued unabated until a pivotal moment in March 2021.

Archegos’ strategy of concentrating its investments in a select group of stocks — specifically, Discovery, ViacomCBS, Shopify, Tencent Music Entertainment, Baidu, and GSX Techedu — initially seemed to pay off, especially with the portfolio’s impressive performance in 2020. However, the tide turned dramatically on March 22, 2021, when ViacomCBS shares began their descent. Such market fluctuations are inherent to investing, yet the consequences are magnified when trading on margin. Archegos operated with a leverage ratio of 5:1, meaning for every dollar of equity, it borrowed five dollars to reinvest, significantly amplifying both potential returns and risks.

The firm engaged in leveraged swap agreements with prime brokers, including Goldman Sachs Group Inc., Morgan Stanley, Wells Fargo & Co., Nomura, and Credit Suisse. These swaps allowed Archegos to control stocks it did not own, with profits or losses reflected on the banks’ balance sheets. Unknown to these financial institutions, Archegos maintained similar positions across multiple banks, enabling Hwang to execute large-scale, debt-driven trades.

The strategy unravelled when the value of its concentrated stock positions plummeted, prompting brokers to issue margin calls — demands for additional funds to cover potential losses. Overwhelmed by the scale of these losses, Hwang found himself unable to meet the margin requirements, forcing the banks to liquidate positions at significantly reduced prices. This cascade of forced sales, precipitated by the high leverage, culminated in monumental losses for Nomura and Credit Suisse, amounting to approximately $2 billion and $4.7 billion, respectively.

This forced selling of assets, a consequence of unsustainable leverage, precipitated the dramatic unravelling of Archegos.

Three Lessons to be Learnt from Hwang’s Failure

The downfall of Archegos Capital Management can be attributed to a potent combination of a few factors: an overconcentration of investments in a limited portfolio of stocks, the employment of excessive leverage, and a critical deficiency in risk management practices.

This debacle underscores three pivotal lessons:

1. The Imperative of Robust Governance

The collapse of Archegos Capital Management underscores a critical lesson in the necessity of robust governance within financial institutions. A significant factor contributing to Archegos’ failure was the lack of transparency in its reporting mechanisms.

Bill Hwang, the man at the helm, had not disclosed returns and performance metrics in regulatory filings, a practice that veiled the true extent of risk within the firm’s portfolio. This opacity in reporting was not new to Hwang; his previous venture, Tiger Asia Management, faced legal sanctions, including a substantial fine by the U.S. Securities and Exchange Commission for insider trading, and a subsequent market ban in Hong Kong for market manipulation.

The continuation of these governance shortcomings at Archegos highlights the vital role that transparency and accountability play in managing risk and safeguarding against catastrophic losses. Had Archegos been founded on principles of strong governance, the excessive risks taken might have been questioned or mitigated before reaching a point of no return.

2. The Danger of Low Diversification

The adage of not putting all your eggs in one basket rings especially true in the context of Archegos’ downfall. Bill Hwang saw his fortune evaporate within days, largely due to an overly concentrated investment strategy. The debacle serves as a stark reminder that while seeking high returns, diversification should not be overlooked.

A well-diversified portfolio acts as a buffer against market volatility and can prevent the total collapse of an investor’s holdings. Archegos’ concentrated bets illustrate how a lack of diversification can expose investors to significant risks, potentially leading to severe financial consequences.

3. The Essential Role of Risk Management

Leverage, when used judiciously, can amplify returns, but it also magnifies losses, as vividly demonstrated by Archegos’ experience. The firm’s aggressive use of leverage without adequate risk management safeguards was akin to navigating a high-speed roller coaster without a safety harness. This strategy put not only Archegos but also its banking partners at grave financial risk.

The Archegos saga reinforces the importance of implementing stringent risk management protocols, especially when leverage is employed, to protect against outsized losses and ensure the stability of the financial system.

The Bottom Line

Consider the story of Jesse Livermore, often hailed as the original “Wolf of Wall Street.” His legendary trades, including short positions before the 1906 San Francisco earthquake and the 1929 market crash, earned him a vast fortune and a place in trading folklore. Yet, despite his financial successes, Livermore faced bankruptcy multiple times and ultimately ended his own life. His journey, marked by the famous sentiment “I want to save myself from myself,” serves as a poignant reminder of the volatility and risks inherent in the financial markets.

This narrative mirrors the Archegos Capital Management crisis, led by Bill Hwang. It underscores a critical principle in investment: the significance of prudent entry and exit strategies. Had Archegos exercised greater caution in its ViacomCBS positions or tempered its use of leverage, the narrative might have veered away from its disastrous conclusion. This illustrates that while fortunes can be amassed rapidly, it is the application of wise investment strategies, underpinned by robust risk management, that sustains and grows wealth over time.

At VAR Capital, we draw from these lessons, prioritizing not only the pursuit of strong returns but also the implementation of rigorous risk management, governance, and portfolio diversification. We believe that our commitment to a disciplined investment approach positions us to offer our clients favourable risk-adjusted returns, navigating through market turbulences with a steadier hand.

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VAR Capital is an independent financial services firm offering asset management, lending and family office services. It was founded by individuals with extensive experience from Banking, Asset Management and Family Offices. Based in Mayfair, London, VAR Capital Ltd is authorised and regulated by the Financial Conduct Authority (FCA).

Source: VAR Capital

Media Contact: Vikash Gupta, vikash@varcapital.com