In The Lonely Bull

Another lesson in the use of leverage in stock trading; the family office, Archegos, recently faced massive margin calls and was substantially liquidated. The calls came about because this entity, operating like a hedge fund, had borrowed heavily to increase its bets on a select number of stocks. When a few holdings of their concentrated portfolio started to go down, their collateral for the borrowed funds, the stocks, lost value to the extent that the loans were called for repayment. Repayment had to come from selling the holdings and even more.

If the stocks sold, pledged for the loan, would not cover the payback, then the loan issuers would be on the hook for the loss. Since the collateral was declining at a rapid rate, each loan issuer rushed to sell the positions, driving prices still lower. The first ones out did the best in recouping their loans. The question remains, “why did so many financial institutions lend such large amounts on the collateral offered?” In some cases, 18 times the value was lent. With this much leverage, it does not take much decline to wipe out the collateral value.

This is a lesson for the banks, but also a reminder that leveraged systems are inherently fragile. The Bull and his partners are always on the lookout for this risk, but it is almost impossible to identify ahead of times. Instead, we invest in such a way as to never need to sell. That gives the flexibility to ride out the inevitable bumps and even, in some cases, capitalize on opportunities that arise from others having to liquidate. This liquidation of Archegos was a minor crisis, but big ones come along periodically. We actually look forward to those opportunities.

The Lonely Bull

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