“Everything I learned I learned from the movies.” ― Audrey Hepburn
If you are like most people, you enjoy a good movie. Personally, I was a big movie person growing up and even as a young adult. Hollywood has a way of making a big impression on those who are full of enthusiasm and optimism. As one grows more familiar with Tinseltown, well, you become less impressed, let’s put it like that. Still, watching a great movie is truly a joy. If you have a good story with great actors, combined with a nice theater, in the company of friends and family, well, that is hard to beat. One of the nice things about cable television has been you can usually find reruns of good films at any time of the day. How can you say no to a rerun of Gone With the Wind, Casablanca, Patton, Top Gun, or even Pretty Woman? The reason I bring this up is over the last few weeks, investors have been treated to their own version of a rerun. Let’s delve into the topic of the now famous family office, the one and only Archegos Capital Management.
Archegos Capital Management was led by Bill Hwang, it’s founder. Hwang was a protege of Julian Robertson, known as the Tiger. Mr. Robertson is one of the great investors of our generation. Mr. Hwang was originally hired by Robertson and made the Tiger quite a bit of money. Hwang was convicted of insider trading in 2012 and paid a $60 million dollar fine. The leading investment banks like Goldman Sachs and Morgan Stanley blacklisted him for quite a while, and then lower tiered banks gave him a second opportunity. Goldman Sachs and Morgan Stanley joined the party, with all the banks providing borrowing capacity through their prime brokerage arms. Mr. Hwang was a fine investor for a long time, and did a fine job of building up the family office to a situation where it had 10 billion dollars of equity value. For any institutional investor, if you control ten billion dollars of equity, you are in a strong position. Unless. Unless, of course, you make a poor decision with respect to risk management. What could that be? Ah. Welcome to our rerun, the same situation we see with the vast majority of blowups. When you look at Long Term Capital Management (run by Nobel Prize winners), Lehman Brothers, Bear Stearns, and now Archegos, there is a common element. In all of these situations, way too much leverage was used. In the case of the Nobel Prize Laureates, they were afforded nearly 100 to one borrowing. Lehman was close to forty to one, as was Bear, and with Archegos, the ratio was about seven or eight to one debt versus equity. Consider the possibility you have ten billion of equity and zero debt employed. Your positions lose twenty percent, you are down to eight billion of equity, but with no time pressure or margin exposure. Apparently, with large debt exposures across Wall Street (think 50 billion ish, with a b), the triggering event was the secondary offering of Viacom CBS. Archegos used total return swaps and other derivative contracts to put on it’s leveraged positions.
Once Viacom CBS started to fall, the axes on the prime broker desks at Goldman and Morgan Stanley sold first and weren’t asking any questions. Risk management divisions at the best investment banks are always the first out the door, and this was a classic example. Naturally, others were left holding the discounted stock, that being Credit Suisse and Nomura. Their losses are estimated potentially as high as $10 billion. Unless you look at the actual positions and see what the market price is versus what it was bought at, you won’t know the extent of their losses. The most important lesson in this ‘movie rerun’ involves the use of leverage, or borrowing, to buy stocks. Don’t even think about it.
In other news involving the capital markets, the March jobs report came in hot at 916k, well ahead of the 675 thousand estimate. Noteworthy in the report was the improvement of employment in the service sector, especially restaurants and hotels. Nice to see, and I hope it continues. On the earnings front, the headline names included Lululemon and Micron, which met their numbers. Walgreen’s, probably helped just a smidgen by the continuing acceleration of vaccine distribution, came up with a big beat as well.
Politically, well, you could argue what we have is a bad rerun, too, so maybe I’ll provide some prime examples. With unemployment coming in at 6% and the economy starting to improve, adding a two trillion dollar spending package after running a three trillion dollar deficit seems a bit, shall we say, questionable. Interestingly, the focus on this spending will be infrastructure, but some estimates show less than half of the two T’s being actually spent on roads, bridges, airports, and other infrastructure related items. In California, Governor Newsome is reported to have lined the pockets of his biggest donors with no bid contracts. Shock. On the other side, we have the Matt Gaetz affairs, literally. There are plenty of great movies about politics, and you might try All the President’s Men if you haven’t seen it. Anyway, I hope you are enjoying the start of spring, even if it doesn’t include a good flick.
Thank you for reading the blog this week, and if you have any questions about investing, please email me at email@example.com.
Yale Bock, Y H & C Investments, its clients, and the family of Yale Bock have positions in the securities mentioned in the blog, Investing in securities involves risk and the potential loss of ones principal. Past performance is no guarantee of future results. All investment decisions should be considered with respect to ones risk tolerance, return objectives, liquidity needs, tax considerations, and one’s overall financial situation. The fact that Yale Bock has earned the right to use the CFA designation does not mean Y H & C Investments will outperform broad market indexes.