welcome back everyone a quick video today on the blow up of Archegos Capital let's talk about who
Bill Huang is, the role of prime brokers and the issues of leverage and the total return
swaps that he traded. let's see if we can learn something useful from the situation.
Now the reason i didn't rush to make a video on this topic is that there's nothing i find more
annoying than the type of person who steps in after a disaster like this to kick a guy while
he's down. It's a bit like when you're watching a sporting event with a friend and an athlete
fumbles the ball and your friend says "what an idiot i wouldn't have made that mistake" and you
think "well of course you wouldn't have made that mistake you're sitting on a couch eating cheetos"
"the biggest mistake you're gonna make today is to spill beer on my couch" you know it's a it's
a different thing so while i could make a video where i make all sorts of jokes about the losses
let's see instead if there are any useful lessons that we could take away from this story
this loss that happened over a day or two has to be one of the greatest losses of personal wealth
in history so first up who is bill wong and is he a dummy well he started out his career
working for julian robertson who's one of the most legendary fund managers julian robertson
ran tiger management which was one of the best performing hedge funds in history and he's
up there with people like saurus buffett and simons he's one of the greats i think he turned
8.8 million dollars into 22 billion dollars over a 20-year period and robertson used to cede the
funds of his top traders when they left his firm and those funds went on to have great returns and
they were known as tiger cubs they often had the word tiger in their name and bill huang is one
of the people seated by julian robertson so it's probably reasonable to say that he's not a dummy
so bill started up a fund that was called tiger asia management in 2001 which went on to be one
of the biggest asia-focused hedge funds managing more than 5 billion at its peak he took a beating
in 2008 during the volkswagen short squeeze but overall had good returns now of course in 2012
he was accused of insider trading in chinese bank stocks he pled guilty to a criminal fraud charge
and paid 44 million dollars to settle his case with the securities regulators he then wound up
his fund and he was no longer eligible to take outside money so in theory at that point bill
might have found himself permanently blacklisted by the investment banks that's kind of what you
would expect but a year later he's back in the game with a family office meaning that he now
managed only his own money and he called this uh archigos capital management so he was now just
managing 200 million dollars of his own money back in 2012 i think most of the brokers wouldn't touch
him but equally when you have 200 million dollars there is always someone who will help out and hold
it for you for a small fee and soon many of the world's top investment banks were competing for
his business so bill was back up and running it's worth being clear that this was not a hedge fund
that's being reported in the press it's a wealthy individual who traded like a hedge fund because he
was a former hedge fund manager and he used the prime brokerage services of the banks to do so
now prime brokerage is kind of like a higher service version of brokerage at an investment bank
and it's reserved for the biggest clients being a family office he'll have gotten much more privacy
than a hedge fund would and that's why he had a reported net worth of over 10 billion dollars
without anyone really hearing much about him at all so he ran his family office for eight years
and in that time he turned his initial 200 million dollars into 10 billion dollars that's
an annualized return of around 63 percent a year over eight years which is just a massive return
the returns might have been even higher as it would appear that he donated 500 million dollars
to one charity and possibly donated to many more charities some of the news are reporting that
he was in business for nine years but i don't think that's true because it took him a year to
wrap up his fund and get going again if the nine year number is correct it means he returned around
55 percent a year and of course over the last week it would appear that he lost all of that money and
more now two of his brokers credit suisse and nomura warned their investors and banking
regulators this week that they face billions of dollars in losses after archigos defaulted on
margin calls between them the banks had lent billions of dollars for highly levered bets
on u.s and chinese stocks nomura warned yesterday that they're facing a two billion dollar estimated
loss and the financial times reports that credit suisse has losses of three to five billion dollars
the people at softbank obviously must be kicking themselves that they weren't involved there
they're slipping so you get anyhow a pretty good understanding of the way that the prime brokers
were thinking about risk and reward when you look at the way goldman behaved in this case
for years they would not deal with huang at all due to his history of insider trading
then suddenly they're doing everything they can to get him as a client and lend him money when
he was a 200 million dollar client the fees they generated would have been small and when he's a
10 billion dollar client who trades a 60 to 80 billion dollar line greed trump's fear it would
appear that huang had prime brokerage arrangements with goldman sachs morgan stanley credit suisse
nomura and deutsche bank and maybe more now the full picture of his positions is still emerging
and it's not yet clear what the catalyst was for this liquidation or what his hedges were but you
can clearly see what the big positions were based on the block sales that we saw in the market
it would appear that he mostly traded single stocks but he did it through total return swap
so he didn't buy the actual stocks he invested in total return swaps and total return swaps are
a derivative that's also known as contracts for difference and they allow you to get the returns
to both the capital gains and dividends of a reference asset without actually having to own
it you enter this agreement typically with a bank which will usually have a funding cost advantage
you usually have to post a smaller amount of capital upfront and thus the position is
leveraged the bank will usually borrow money at its funding cost and buy the underlying stock
as a hedge and you can see that banks like goldman and morgan were the largest holders of some of the
stocks that were liquidated and they probably held these positions in order to hedge the swaps total
return swaps can be used to hide your ownership of a stock but that doesn't mean that you can use
them to break the law there was a fund called the children's investment fund which despite
its name was not run by children and they got in trouble a few years ago for using them to avoid
disclosing that they built a position of greater than five percent in csx corp another interesting
feature of these swaps is that while they give you the economic exposure of owning the stock
they don't give you the voting rights and that means that in theory you could buy a stock sell
total return swaps and be left with voting rights without being exposed to the returns of the stock
anyhow it would appear that bill huang mostly just used these things for leverage and to maintain his
privacy and intrude mostly just for leverage so do i feel bad for the brokerages that lost billions
in this not really i feel that they knew who they were dealing with they knew how much leverage they
had given him and they made their bet and they lost the news tells us that he was levered between
five times and eight times his returns were in the range of between 55 a year to as high as possibly
70 a year for eight or nine years and to me this is like letting lewis hamilton borrow your ferrari
and then getting upset that he drove it a bit fast what were you expecting it's what he does right
we'll probably learn more as more news comes out but it's somewhat surprising that he wiped out in
this market environment over his career he'll have traded through the ltcm meltdown the dot-com boom
and bust september 11th attacks the financial crisis and the coronavirus meltdown a year ago
he was also on the wrong side as i mentioned earlier of the volkswagen short squeeze
and survived that that was sort of the old version of the gamestop short squeeze and i'm kind of
amazed that he made it through all of those situations and then got carried out last week
there are a few other interesting parts to the story bloomberg is reporting that the
prime brokerages facing huang's position had a call in the middle of last week during which
credit suisse pitched that the bank should coordinate to slowly unwind their positions
apparently this was agreed upon and the story then goes that first goldman and then morgan broke the
deal and began dumping their positions that's the the big block trades that we saw on friday
and then hearing that one of these banks once they'd exited their positions leaked the story
and that's why credits reason no more are left holding the bag representatives of the banks
declined to comment to bloomberg when asked about this but i would think that if that deal actually
did occur it strikes me as possibly illegal so what is prime brokerage it's it's a business
that got big in the early 2000s at the start of the hedge fund boom back then the brokerages were
earning high fees from these clients and competed with each other for business they would help
a hedge fund find an office that'd help you find staff they'd introduce you to potential investors
along with providing brokerage services i have a friend who jokes that being an investment banker
today is a bit like being a stewardess it used to be highly paid and glamorous but it's no longer
either of those things today prime brokerage is a low margin business it uses lots of capital
and it leaves the bank with a lot of tail risk for some of the banks this blow up will have wiped out
a decade's worth of profits it's not really obvious to me why some of them are even
in that business anymore i think they just like being able to say that they deal with the biggest
and brightest hedge fund clients it's more about the prestige than the return on capital years ago
the the big banks used to have proprietary trading desks that traded like hedge funds
politicians then passed laws that shut down prop trading and now the banks are just exposed to
these risks through their clients like we see in this event that not only are they exposed to
these risks but they don't earn any of the returns if it goes well and as a friend of mine said to
me this morning we need smart well-paid people in government who make better rules so for bill huang
it looks like he's lost everything he made a big bet and he lost and this is really almost just a
huge scale version of the stories you hear about a trader a wall street bets trader levering up their
robinhood account and wiping out one of my first big videos here on youtube was a video on leverage
and position sizing and it explains why trading too big is almost guaranteed to wipe you out
even if you have an edge and i'll put a link to that video in the description below if you haven't
watched it it's kind of worth watching i guess the final part of today's video is that bloomberg
news spoke to bill huang's former employer the legendary fund manager julian robertson
who i mentioned earlier and julian spoke very kindly of him he said that he was a
good guy who made a terrible mistake and hurt himself more than anyone see you guys later bye