Bad year for hedge funds

It was only two months ago that we wrote about hedge funds suffering big losses after markets when against their leveraged bets.  Well, it has happened again and the losses this time have led to a huge destruction of wealth.

Last week Archegos Capital a family office was forced to liquidate some of its very concentrated and leveraged equity positions at a loss.  The hedge fund which was able to not disclose some of its large equity positions due to its family office status faced margin calls from its lenders when the stocks that it held plunged.  Since Archegos couldn’t pay up, the banks stepped in and dumped the shares.  The fact that the fund held a handful of positions and used borrowed money to make outsized bets means most of the family fortune was lost.

In the wake of this forced selling, two banks, Credit Suisse and Nomura suffered heavy losses due to their exposure to Archegos.  Their respective shares dropped as they disclosed their link to the family office and warning of significant losses to their earnings.  It is estimated Credit Suisse lost around $5 billion and Nomura $2 billion.

The events that have unfolded in the past week remind us that risky trading is still very much part of markets today and financial professionals are quick to forget errors of the past.  The extreme leverage and secret derivatives that were used led to this great debacle.  Furthermore, the banks that lent funds and allowed the leverage failed in their risk assessment since the manager of Archegos, Bill Hwang, was previously found guilty of insider trading and was effectively banned from trading on the Hong Kong stock exchange.  The fund’s status as a family office allowed it to use derivatives such as swaps to hide its identity and take enormous positions which also shows regulatory failings.  Investors who own more than 5% of a company are required to report to the SEC but not in the case of derivatives.  Despite this series of mishaps, one wonders if the financial industry will learn a lesson from this and it wouldn’t be surprising to see the manager at the helm of a new fund in no time.