“In March, the hedge fund Archegos struck an iceberg. In just two days, the highly leveraged fund went from “business as usual” to total collapse. Performance rapidly degenerated; the fund was unable to meet margin calls; its bankers seized its collateral; the fund was out of business. Archegos lost everything.
Although Archegos was held only by founder Bill Hwang’s family, its saga offers broad investment lessons.
Victories can be hazardous. They present temptation enough for retail investors, who frequently, as the saying goes, confuse brains with a bull market. After making a couple of winning trades, it’s natural to assume that the trend will continue. The first two times I bought a stock, I doubled my money within 12 months. I had enough experience to know that some of that gain owed to luck, but not enough to know that all of it did. Never since then have I repeated that feat.
Imagine, then, the position of professional investors, who possess the additional hazard of occupational ego. Their livelihood depends upon their ability to best their rivals. Such competition is not for the timid; it demands a high degree of self-confidence, to overcome the lingering doubts. What’s more–although this point did not apply to Archegos, which operated privately–public fund managers face shareholder pressure to demonstrate “the courage of their convictions.”
Bill Hwang certainly showed the courage of his convictions. He grew the fund to $10 billion by borrowing mightily, and after that triumph, continued borrowing mightily. Estimates for the fund’s final leverage ratio range as high as 8 to 1, meaning that even a modest loss would have consumed the fund’s equity. Which is in fact what happened. Archegos wasn’t destroyed by a huge bear market–it suffered what should have been a temporary decline, but which became permanent. Pride went before the fund’s fall.” – John Rekenthaler