How To Lose $20 Billion In Two Days

The story about how Archegos Capital Management performed a disappearing act with $20 billion it managed in as few as two days is shocking, but it’s also sad. Its manager, Bill Hwang, has a bit of a checkered past from a regulatory perspective, but it seems, by the accounts of many, that he was a purposeful man who thought about the impact of his wealth from a philanthropic perspective as well as its management.

So while I’m not inclined to pile on the Bill-bashing bandwagon, I am inclined to share with you three ingredients for putting your personal wealth at extreme risk if you should choose—and three counteragents that I hope will help you avoid this recipe for potential disaster and embarrassing failure:

1. Hubris – “Amassing of wealth is an opportunity for good deeds, not hubris,” Thucydides said. Hwang seemed to have the good deeds part down, even sharing Archegos’ pricy Midtown real estate with the nonprofit of his creation, the Grace & Mercy Foundation. But in the end it was hubris, a step beyond pride, that apparently led Hwang to believe he was the most brilliant among the myriad of bright bulbs in the investing landscape. And this was his undoing.

Please think about this for a second: The total global stock market represents a collective community that includes every one of the very smartest—and occasionally luckiest—investing minds on the planet. This means that when your brother-in-law who sells pharmaceuticals tells you that you should back up the truck and dump all your retirement funds into his startup firm because they’re about to get FDA approval, he’s either sharing inside information (which could put both of you in jail if it’s acted upon) or he’s sharing something that hundreds, thousands, or even millions of investors already know…and have acted on.

By the time you jump on whatever late, great investment idea you or your brother-in-law have hatched, a multitude of people—and the institutions whose profitability depends on analyzing this stuff 24 hours a day—have already weighed that information and weighed in on their opinion of its meaning with their own buys and sells. This doesn’t mean you can’t guess right and make a fortune; it just means that by the time you implement any market-timing strategy, the investing universe has already priced in the collective opinion of everyone else.

  • The counteragent to hubris, therefore, is humility. By applying an evidence-based approach to investing that presumes the market will work it all out in the long run (a concept known as market efficiency, around which a host of Nobel prizes have been doled out), you can hopefully find yourself on the winning side of the trade against the many gamblers who are trying to outsmart the market. The other big advantage of this strategy is that you’re sitting back and relaxing while all the market timers compete over the finite scraps of short-term inefficiency that have fallen off the table.

2. Concentration – When hubris is in the driver’s seat, we become blinded to alternatives and options. We see the world, and investing, through the single lens of our own making. Because if you knew for certain that your idea was the best, and that you couldn’t lose, you’d make an all-in bet on that strategy. That’s the type of certainty with which Archegos seems to have made its recent moves.

Hwang put his money on a relatively few companies, most notably, ViacomCBS and Discovery Inc.—the other side of the winning bet of late in the entertainment space: Apple, Disney, and Netflix. So, when news broke that ViacomCBS faced challenges in challenging the big dogs, the stock—and Archegos with it—started taking huge losses.

Again, I want to be clear that to make headline-worthy gains and have a story to tell your friends at cocktail hour (for the fully vaccinated, of course), you likely need to concentrate your investment positions. But concentration kills more financial plans than it rewards, and you could always choose to talk about something more interesting than stocks and perhaps look to make an impact on the world that is greater than your gains.

  • The concentration counteragent, as you may have expected, is diversification. Yes, I know you’ve heard it before, but it can never be said too many times because the siren’s song of concentration will always be strong enough to require tying ourselves to the mast stamped with the words rationality and reality. And beyond the reward of sleeping at night, because you don’t need to worry if this-or-that company is going under because you own thousands of them, diversification comes with the added benefit of smoothing out the rough ride that even a large slice of the market (like tech stocks in 2021) often delivers.

3. Leverage – The truth is that Archegos’ losses—and the losses of the host of firms that have now become part of its fallout—wouldn’t have been nearly as fatal if it weren’t for this last point. As an outgrowth of its hubris, Archegos not only concentrated its positions, but it then borrowed money to compound its bets four to five times the magnitude of the money it was investing! It “likely had borrowed roughly $85 million for every $20 million, investing $100 and setting aside $5” to serve as a buffer, Bloomberg reported.

This is a microcosm of what happened in our last financial crisis—you know, the one before the COVID-crisis that began with the collapse of the housing market and resulted in a market and economic disaster. In that case, banks packaged mortgages in bonds that were then repackaged in other securities that were subsequently bet on with derivatives. Just read Michael Lewis’ book, “The Big Short,” if you want to know more. (The movie is info-taining as well.)

These stories make for good drama, but they simply don’t end well for most involved.

  • The counteragent for leverage is reason. It can’t simply be abstinence from using leverage, because there are times when leverage can be wisely employed—such as in buying a home at a great, low, fixed interest rate with a healthy down payment or raising money for a new business venture that would never get off the ground without an infusion of cash you don’t have. But while there are isolated examples where investing with derivatives may make sense, they destroyed Archegos and have sent a shockwave through the financial system. And no, I don’t ever recommend investing with margin—borrowing money to invest more than you have.

A friend of mine recently asked me a sidebar question related to investing: “Hey, I know your message on all the stuff that you write and recommend for your clients…but what do you do?”

Thankfully, this is one area of life where I faithfully practice what I preach. While I dabbled in market timing and option trading early in my career, over 22 years in the industry, I’ve seen too many humbled by hubris, concentration, and leveraged investing. I eat my own cooking, and I’m not looking for excess excitement from my portfolio. I’m hoping, instead, that the steady accumulation of wealth over time will help fund exciting adventures in real life.

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