$20 billion???!!!
That's right. That is $20,000,000,000. Probably something most folks of 99.9% of this world will never see in their lifetime in their bank accounts.
If you are wondering what we are referring to, this is the Bill Hwang-Archegos saga that unfolded in March 2021. How did that happen? You might have already read about his fall but just to recap, here is what transpired.
Hwang is known for his investment strategy using leverage. This means you borrow money to make money. The money is not yours. It is a loan from someone else. In his case, a number of institutions. He then takes that loaned money and places investment bets on companies that he has confidence in the stock rising. The interesting part is that those bets are heavily concentrated. These were shares that included well-run and viable companies like Discovery and ViacomCBS.
Typically, in this approach, if there is low correlation between the shares, one share price drop will be held up well by others to provide a good cushion across the portfolio. But somehow, this did not turn up to be the case.
When you take a loan to do such things, the banks that loaned you the money have the right to do a margin call on you. What is a margin call? It is a place where you have to put up money upfront to provide assurance that what you have borrowed is “safe”. Hwang’s strategy of concentrating his bets was done through equity swaps. This is where those banks that loaned him money would own those stocks directly and when the margin call was made and Hwang could not meet those requirements, the banks were left holding the bag.
That people, has some level of risk involved. But what is crazy is not that he was levered, but the EXTENT of the leverage. Did you know that he borrowed up any where from 5x to 10x what he actually had? This meant that for every $1 he had, he was borrowing at least $5 on that amount.
If the amount he borrowed was 10x, all the stocks that he was in just needed to fall by 10% and he would be wiped clean. Such was the risk that Hwang found himself in. That was to the tune of more than US$100 billion, of which about $10 to $20 billion was his personal wealth ( https://www.bloomberg.com/news/features/2021-04-08/how-bill-hwang-of-archegos-capital-lost-20-billion-in-two-days.)
The biggest leverage was provided by Credit Suisse that gave Hwang 10x leverage, asking for just 10% of the sum borrowed. Naturally, it bore the brunt of the entire fallout. Its shares took a dive thereafter (https://www.theedgemarkets.com/article/credit-suisse-gave-archegos-big-leverage-little-collateral.)
What lessons can we learn here?
- Never take on a leveraged position unnecessarily. The amount that you must be willing to lose cannot be more than the shorts that you are wearing. What this means is that you will need to strike a good balance between taking risk and crossing the line in taking EXCESSIVE risk. Once the tide goes out, Buffett says that you will really know who is swimming naked. And boy, Hwang really had NO TRUNKS on.
- Always be prepared for black swans. Regardless of your track record, never allow yourself to get so ahead that you fail to see where you land. Pride always comes before a fall. And with many years of doing that same thing over and over, Hwang was probably very confident in what he was doing. He would have probably increased leverage to keep growing his winners…. Until they became overnight losers and the game was over.
Till the next time,
Chief Editor
BBA Market Perspectives
