What happened to Archegos? And could the same thing happen to a local fund?

By Janice Roberts, Editor: MoneyMarketing

Last week Friday, Archegos Capital Management – a family office in New York City – had to unload $20bn dollars of its shares, due to it not being able to meet its margin obligations to lenders. Consequently, share prices of Chinese companies Baidu and Tencent, plus US stocks such as ViacomCBS and Discovery, crashed. The banks that suffered most appear to be Nomura and Credit Suisse.

So, what happened to this firm that few people had ever heard of before this incident last Friday? MoneyMarketing’s editor, Janice Roberts, spoke to Marthinus van der Nest, Head of Amplify.

MM: What happened at Archegos Capital Management and what should MoneyMarketing’s readers know about margin calls?

MvdN: Archegos Capital Management were caught on the wrong side of a trade and were highly leveraged.  When caught on the wrong side of a trade, a bank can call on you to make a deposit (called a margin call) to cover the paper loss.  In this case, Archegos did not have sufficient capital to cover the margin call. The alternative was then to sell shares and the paper loss was then materialised.  The frantic selling then caused the share prices to decline further.

MM: Are margin calls pretty regular in investing?

MvdN: They are when a position goes against a fund.  But it is important to understand that risk management is key in managing a hedge fund.  What happened in this case was that a hedge fund manager had highly leveraged positions and high exposure to individual stocks. Typically, you should be looking at managers that are good risk managers and have many smaller positions.  The effect of an event like this is therefore much smaller and much easier to manage for a hedge fund manager.

MM: It’s been suggested that globally, investors are more worried about missing out on gains than of losing money. But does this mean that funds should engage in enormous leveraging?

MvdN: No, the problem is investors don’t like either.  When performance is not as they expected they will sell an investment often at the wrong time.  Highly leveraged funds will always have the problem that they could incur permanent losses.  We typically look for managers that are able to provide us with upside participation but have the proven ability to protect investors on the downside

MM: Could investment banks be partially to blame for Archegos’ situation in that they handed out money to the hedge fund without proper consideration of getting it back? 

MvdN: There is still information about this event that we don’t know about.  It seems the proper disclosures were not made by Achegos Capital Management.  In the US, once you have a position in excess of 5% in a particular security, then that should be disclosed to the market – which didn’t happen in this case.  So, you need to ask questions about the integrity of the manager.  With our own funds we receive risk reporting from an independent business on a daily basis.  If any breaches are incurred by one of our managers, they are instructed to rectify them immediately.

MM: Should one take away from Friday’s Archegos Capital Management issue that there are dangers involved when trading with borrowed money?  

MvdN: If we are talking about hedge funds specifically, there are many hedge funds that have performed very well over many years.  When risk management is applied correctly,  borrowed or leverage can certainly work to the benefit of the investor.  It is important to keep in mind that when one fund blows up it grabs all the headlines.  The vast majority of hedge funds around the world don’t and won’t blow up.  Understanding the manager, and the risk employed by the manager is critical before investing in hedge funds, and not from the perspective of the blowing up or not, but to understand what your performance expectations should be.

MM: In the current investing environment, what are the chances of a local hedge fund experiencing an ‘Archegos situation’? 

MvdN: The South African hedge fund industry is very well regulated.  Looking at our own business, we monitor the risk of each manager very closely.  Any risk breaches need to be addressed immediately.

MM: Is it possible that the Archegos incident could lead to investors cutting back popular and overstretched investments and favouring those investment with a greater margin of safety? ie. Will the swing from ‘Growth’ to ‘Value continue?

MvdN: If it does, the risk is more to the investor.  The right hedge funds provide an important diversifier of risk and uncorrelated performance versus traditional long only products.  Being invested in products with a higher margin of safety often leads to reduced returns which means you miss you returns expectations.  ‘Value’ vs ‘Growth’, who knows?  A well-diversified portfolio is key for investors.