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Markets Tumble Following Unknown Hedge Fund Bankruptcy

Since July 2020, Chinese stock indexes have been on an upward trend, which was especially pronounced in March. This trend caused Archegos Capital last week to run out of funds to cover its leveraged positions.

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On Monday, the financial markets were shaken with slight declines in the main stock market indexes, as the Standard & Poor’s 500 Index varied negatively by 0.09 %, while the Nasdaq varied negatively by 0.60 %. Although the change may go almost unnoticed, it was due to practically a single event, the bankruptcy of a small and little-known hedge fund, “Archegos Capital Management.”

Archegos Capital Management was a family office investment fund that specialized in investing in the shares of companies in the United States, Japan and South Korea. The hedge fund had been actively engaged in buying short positions, (i.e. selling someone else’s asset in the hope that its price would fall in the future, then buying it back, repurchasing it from the original owner and earning the difference between the sale and the repurchase), of shares in Chinese technology companies.

Since July 2020, Chinese stock indexes have been on an upward trend, which was especially pronounced in March. This trend caused Archegos Capital last week to run out of funds to cover its leveraged positions.

Although the U.S. Securities and Exchange Commission has not yet detailed the size of Archegos’ losses, there is speculation that the hedge fund had between $5 billion and $10 billion in capital, in addition to positions in excess of $50 billion, which would indicate massive indebtedness relative to the fund’s actual capital.

Hedge fund - Archegos Capital - El American
The markets recorded millions of dollars in losses due to Archegos’ default. Credit Suisse was among the most affected banks. (EFE)

Goldman Sachs and Morgan Stanley, both lenders to Archegos, in order to avoid the loss of the money owed, decided to execute forced liquidations of Archegos’ positions in the market worth close to $30 billion. The withdrawal of Archegos’ positions caused the share price of companies in which Archegos had invested to fall. Some of these affected companies include ViacomCBS Inc. and Disvoery Inc. along with the bankruptcy of the investment fund.

Germany’s Deutsche Bank AG also managed to evade losses from the Archegos bankruptcy by replicating the actions of Morgan Stanley and Goldman Sachs. “We are managing the client’s remaining immaterial positions, on which we do not expect to incur any losses,” a Deutsche Bank spokesperson said.

However, the financial drama did not end there, Archegos had contracted debt with other entities, which were also forced to liquidate positions in their portfolios to avoid further losses due to the default of the investment fund. Indeed, according to the Financial Times, the bank Credit Suisse lost between $3 billion and $4 billion due to the failure of the investment fund, while the financial holding company Nomura lost up to $2 billion.

With Nomura and Credit Suisse announcing losses in the millions, the markets reacted by rushing to sell the companies’ shares, causing the market capitalizations of the Swiss investment bank and the Japanese holding company to fall by 14% and 16%, respectively.

Today, Tuesday, the Archegos bankruptcy revealed new victims. One of Japan’s largest banks, Mitsubishi UFJ Financial Group, revealed that it could lose up to $300 million from exposure to the default of a client in the United States, whose name was not disclosed by the Japanese group.

Suprise for the markets

Although the losses generated by the bankruptcy of a small investment fund may be disconcerting for the financial markets, it is not the first time it has happened. Some analysts have begun to compare the Archegos case to the bankruptcy of Long Term Capital Management in the 1990s.

Long Term Capital was a hedge fund with returns in excess of 40% on investment before collapsing. This fund was advised by Nobel laureates in economics Robert C. Merton and Mayron S. Scholes.

The Russian debt crisis caused a massive devaluation of the ruble which led thousands of Russians to exchange their currency for dollars. In the picture, a man comes out of an exchange in Moscow with a sign on the wall saying “There are no more dollars”. (EFE)

The high returns Long Term Capital guaranteed came at the cost of massive leverage – while the investment fund took positions totaling $100 billion, it had only $5 billion in capital. Among the many “foolproof” investments Long Term had made with borrowed money was the massive purchase of Russian sovereign debt bonds.

In 1998 when Russia defaulted on its debt (leading to the so-called “Russian bond crisis”), Long Term Capital found itself in a mess that would cost it its existence, losing more than $4 billion, almost 75% of its capital, in just a few days.

Bill Clinton’s administration, fearing panic in the financial markets caused by the assured bankruptcy of Long Term Capital, decided to intervene and assume the losses of the investment fund and then liquidate all its assets.

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