Like so many wealthy investors, Bill Hwang put a premium on privacy and made full use of the opacity that a family office can enjoy compared to other species of investment firm. Unfortunately, the recent spectacular blow up of Hwang's family office, Archegos Capital Management, could not be kept private. Having wiped out an $8 billion fortune in the span of 10 days, Archegos has been pulled fully into the public spotlight over the past several weeks.
What blew up this multibillion-dollar investment firm in such short order? The same thing that has blown up so many other overly aggressive investors: too much leverage.
A long love affair with leverage
Hwang has had an impressive career. Having gotten his start as an equity salesman in the 1980s, he quickly moved onto bigger and better things after being recruited by Julian Robertson (Trades, Portfolio) of Tiger Management. With $36 billion in assets under management across its hedge funds at its height, Tiger Management was a force to be reckoned with β and provided Hwang with ample opportunity to hone his skills as an investment manager. By 2001, Hwang was managing his own fund, Tiger Asia, which Robertson staked with $1.2 billion.
At first, Tiger Asia did very well. Hwang's principal focus on Asian stocks and securities gave his fund exposure to a number of dynamic and rapidly growing economies with increasingly bubbly capital markets. By the end of 2007, Tiger Asia had delivered a 40.4% annualized return since inception, a result owed in large part to Hwang's strategy of using extensive leverage to juice up returns. Heading into 2008, Tiger Asia's assets under management had grown to nearly $8 billion.
Things began to go off the rails for Hwang in 2008. Tiger Asia was among the hedge funds that found themselves on the wrong side of the Volkswagen AG (XTER:VOW3, Financial) trade. Hedge funds (among them Tiger Asia) shorting the German automaker were caught in a brutal short squeeze in October, resulting in collective losses to the tune of $30 billion in just a few days. And the hits just kept on coming for Hwang. In 2010, he came under investigation by the Securities and Exchange Commission for allegedly engaging in illegal trading of Chinese bank stocks.
Bad bets and regulatory troubles weighed on Tiger Asia's latter-day performance. In his 2012 letter to investors, Hwang said that Tiger Asia had managed to deliver a 15.8% annualized return since inception β a far cry from the 40.4% it boasted five years earlier. Clearly, Hwang's appetite for leverage had proven costly.
Having settled his case with the SEC in December 2012 by agreeing to pay $44 million, Hwang left the hedge fund world behind, turning his attention to his new family office, Archegos Capital Management. He started Archegos with $200 million, but this figure grew rapidly over the coming years as the early years of Tiger Asia seemed to repeat themselves. By 2021, Archegos had $10 billion under management.
Laid low by leverage at last
While Hwang's investment vehicle may have changed, his strategy had not. Like Tiger Asia, Archegos often took heavily leveraged positions to spike returns. If anything, Archegos was even more leveraged than Tiger Asia thanks to the enthusiastic help of a number of large investment banks. As The Hustle's Trung Phan explained on April 4, this created the conditions for a catastrophic meltdown:
"To juice returns, Hwang deployed a financial instrument known as a Total Return Swaps (TRS). In exchange for a fee, he bet on the direction of a stock and gained exposure w/o paying full price (it effectively created 5x leverage)...While Archegos portfolio swelled to $15-20B, it's total exposure was $100B+."
Hwang's leverage bomb was primed to explode. All that was needed was a spark. That came in the form of ViacomCBS Inc. (VIAC, Financial), which had seen its stock soar 800% from March 2020 to March 2021. The media giant decided to take advantage of its frothy share price to raise capital, announcing plans for a stock sale on March 22 and pricing the $3 billion secondary offering on March 24. The market reacted poorly to the news of dilution, sending ViacomCBS's stock tumbling 55% over the course of a week. For Archegos, which had seen its stake in ViacomCBS balloon to $10 billion ahead of the offering announcement, this was a catastrophic reversal, as Phan observed:
"If a portfolio is levered 5x, it only takes a 15-20% sell-off to wipe an investor out."
Overleveraged and overexposed, Archegos was utterly crushed by the ViacomCBS reversal. Hwang had seen his multibillion-dollar fortune erased almost overnight.
Obey the Oracle of Omaha
The tragic end of Archegos Capital Management, and the resultant destruction of Hwang's fortune and reputation, should stand as a warning to all investors about the danger of indulging in leverage. It can do wonders when you are winning, but it is a terror when things go wrong.
Warren Buffett (Trades, Portfolio), one of the most successful long-term investors in history, has spent years cautioning investors of all stripes about the perils inherent in the use of leverage in an investment strategy. Buffett has oft referenced the advice of Charlie Munger (Trades, Portfolio), the venerable vice chairman of Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial), when speaking on the subject:
"My partner Charlie says there's only three ways a smart person can go broke: liquor, ladies, and leverage. Now the truth is β the first two he just added because they started with L β it's leverage."
Perhaps if Hwang had heeded Buffett and Munger, he would not be in the unfortunate position in which he now finds himself. While it may be too late for Hwang to take their advice to heart, other investors may yet profit by it.
Disclosure: No positions.
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