Views: Nirgunan Tiruchelvam: Fund manager Bill Hwang’s collapse is like the sinking of the Titanic

The Titanic sank into the icy Atlantic exactly 109 years ago. The tragedy claimed 1,635 lives in April 1912 on its journey from Southampton to New York. It was the largest ship in the world, as well as the fastest ocean-liner. Its speed and safety were rooted in its engineering superiority. The passengers ate on plates made of the finest porcelain. Diners were regaled by a live orchestra. The first-class tickets cost US$4,350 (US$115,000 or $154,000 in today’s money).

The Titanic sank within three hours of hitting an iceberg. The lifeboats could only hold 2% of the passengers.

A tragedy of Titanic proportions hit the markets last month. Archegos Capital Management, a family office owned by Bill Hwang, collapsed with more than US$50 billion of exposure. The amount of US$50 billion is twice the GDP of Cambodia. A family office is a private investment vehicle. It is used by rich people to extract returns in a tax-efficient manner.

‘Tiger cub’

Hwang is a Korean-born American who is in his late 50s. He was a titan of the hedge fund field a decade ago.

He was a prodigy of Julian Robertson, a pioneering hedge fund manager. Robertson, who is worth US$4.4 billion at the age of 88, delivered 32% return in the 1980s while managing Tiger Management. This was three times the return of S&P500. Investors flocked to back him.

Hwang was one of the “Tiger cubs” who were anointed as Robertson’s successors. Robertson closed the Tiger Fund in 2000. Hwang’s own star rose after the retirement of his mentor. He accumulated up to US$8 billion in assets under management from 2000 to 2012.

In 2012, Hwang was found guilty of manipulating Chinese stocks through insider trading. He was barred from investing other people’s money and fined US$44 million.

But Hwang, the son of a pastor, had a second coming. He converted his US$200 million personal fortune to a family office. It was named Archegos, which means the Chief Leader or the Prince of Christ in Greek.

In less than nine years, Hwang increased the assets of his family office by a factor of 50. This amounts to a CAGR of 54%, or five times the return of the S&P500. Hwang not only exceeded the returns of his mentor, but his performance eclipses that of Warren Buffett too.

Hwang’s outrageous success was not through buying and holding cheap stocks. Like the Titanic’s speed, the magic carpet was rooted in engineering. In this case, the engineering was financial, not nautical.

Hwang used total return swaps (TRS) to exaggerate his returns. TRS is a derivative product that allows investors to make large bets on stocks with small amounts of capital. For instance, you could use US$20 of Hwang’s money to buy US$100 of Viacom, using US$80 from the prime broker. If the stock doubles, you have made US$200 from US$20. Hwang turned water into wine with the magic of leverage.

The trouble was that Hwang seemed to have ignored the first rule of investing. He put all his eggs in one basket.

Hwang’s core holdings comprised about nine stocks that were in the American media and Chinese tech space. They included Viacom, Baidu and Tencent Music. This basket of stocks may have had an annualised return of 50% in the last three years.

With five times leverage (some accounts suggest that Hwang may have even more than that), he could have increased his asset size by 20 times!

Archegos hit an iceberg while it was smoothly sailing. Viacom lost 52% of its value from March 22 to 26. Archegos had a large (and undisclosed) exposure to the stock, which was liquidated. That caused an avalanche of block trades in other Archegos trades.

It was like the stampede on the Titanic. Thousands of passengers were running to get into 20 lifeboats. On a single day, his nine core holdings had dropped 50% and Archegos was bust.

The Titanic disaster led to better safety measures on ships. Some of them are still used, like high bulkheads to prevent sinking. Similarly, the Archegos debacle may lead to better regulation. TRS may be required to trade on an exchange to increase transparency. If so, Hwang may not suffer in vain like the victims of the iceberg. E

Nirgunan Tiruchelvam is head of consumer sector equity at Tellimer. He does not hold any position in the stocks mentioned in this column