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Why the Archegos debacle is raising renewed fears of market excesses

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The collapse of Archegos Capital Management, which is set to bring hefty losses to a number of exposed investment banks, has again thrown the spotlight onto outsized leverage held by hedge funds and investment managers, and raises renewed fears over excessive liquidity across markets.

Patrick Ghali, managing partner and co-founder at Sussex Partners, believes this week’s Archegos upheaval – coupled with the still-unfolding Greensill debacle as well as potential issues relating to SPACs further down the line – are symptoms of “general excess” in markets.

Archegos is understood to have built up a highly-concentrated portfolio of hugely-levered positions across a range of stocks, taken via the equity derivatives market mainly in the form of total return swaps. 

After the firm defaulted on a series of margin calls by a number of investment banks last week, Credit Suisse and Nomura separately warned they each faced “significant” losses amid the disorderly unwinding of some USD20 billion of Archegos’s wayward bets.

“I’m very concerned. Everything feels quite bubbly right now,” Ghali said of the fallout. He told Hedgeweek on Thursday there are “obviously questions about risk management”, both at Archegos and the banks.

“Using derivatives makes it more difficult for banks to really understand what their exposure is,” Ghali observed. “I don’t see how a bank can lose a quarter or a year’s worth of profitability with one client, which is what seems to have happened here. I’m surprised that banks have such exposures that it wipes out their whole profitability for a year.”

He added: “We’ve been very vocal about our concerns for a while now regarding the whole credit space and the lending space. We remember 2008 very well – it wasn’t that long ago. A lot of these lending strategies ended up blowing up. There were huge valuation issues when the liquidity stopped.”

While New York-based Archegos – which was founded by Bill Hwang, one of a number of former “Tiger Cubs” who previously managed money at Julian Robertson’s Tiger Management – has been described variously as a hedge fund and a family office, Ghali believes its “aggressive” trading strategy makes it something of an outlier in both spaces.

The firm is not typical “in any way, shape or form” of a family office, he said while adding most hedge funds have strong risk controls in place.

“Most hedge funds don’t have this sort of leverage. This is something we as a consultant look at – we try to understand how levered a fund’s positions are,” he explained. He said a typical market neutral hedge fund strategy will tend to be 100 per cent long and 100 per cent short.  Archegos, he added, “was nothing like that.”

“A typical family office is very conservative, multi-generational, wealth preservation-focused. I don’t think this was the norm.”

Meanwhile, Andrew Beer, founder and managing member of Dynamic Beta Investments, believes Archegos’ demise has flagged up the perils of crowded single stock risk.

“Crowded single stock hedge fund positions have been a growing issue, especially as large funds grew larger during the 2010s, and with more and more fund managers trained to look at stocks in the same way. GameStop reminded us crowded short positions can lead to outsized losses; in March, we have seen crowded hedge fund longs suffer,” Beer said.

He indicated regulators will now “closely examine” whether banks deliberately enabled Archegos and its peers to circumvent rules around the disclosure of large stock positions.

Pointing to Greensill, Ghali said there had been a deviation away of having “lots and lots of loans to lots and lots of people”, adding: “What we’ve seen time and time again, as in 2008-2009, is that there is so much scope in some of these strategies for people to take more risk. I’m sure we are going to see more issues. If the liquidity were to stop tomorrow, I think you would have a problem.”

On Tuesday, Wells Fargo & Company revealed it had a prime brokerage relationship with Archegos, but stressed it was “well collateralised at all times” over the last week, and no longer had any exposure. “We did not experience losses related to closing out our exposure.”

Deutsche Bank meanwhile is understood to have offloaded USD4 billion of holdings relating to the Archegos blow-up, avoiding the potentially huge losses faced by other banks. London-based hedge fund Marshall Wace is said to be one of the buyers, Bloomberg reported on Thursday.

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