Archegos, GameStop events offer lessons on risk

The two market crises that dominated the first quarter of 2021 offer important lessons about risk and changing market dynamics, even if they don't prompt changes in investments.

Both the high-volume retail trading in GameStop Corp. shares and other meme stocks in January and the leverage-induced meltdown of family office Archegos Capital Management LP in late March offer lessons about risk management for institutional and other investors, sources said.

"You need to pay attention to these kinds of issues because of implications on market structure, but in cases like these, you don't need to spend six hours down a rabbit hole researching them," said Ian Toner, San Francisco-based chief investment officer of investment consultant Verus Advisory Inc.

Consultants said for the most part they haven't fielded many questions from clients about the two market events. But several consulting firms and hedge funds-of-funds managers said while the Archegos debacle was a one-off event that didn't affect many other market participants, the way that retail investors en masse engineered a short squeeze on stocks some hedge funds held, including GameStop, is of more concern going forward.

"GameStop was less an anomaly and more about a change in market behavior. It's something to watch in the future," said Craig G. Bergstrom, managing partner and CIO of alternatives manager Corbin Capital Partners LP, New York.

"Archegos was about the dangers of leverage and GameStop was a reminder about the dangers of shorting. The lessons learned from Game- Stop were a reminder of the potential of unlimited loss, the new impact of social media, reasons to beware disclosure of short positions and crowded short positions," he added.

Corbin Capital managed $8.1 billion as of March 31, $5.5 billion of which was in hedge funds-of-funds strategies.

Adam B. Blitz, founding partner, CEO and CIO of alternatives manager Evanston Capital Management LLC, Evanston, Ill., said that "it all came down to risk control for both market events" and agreed with Mr. Bergstrom that the impact of the GameStop trading activity was more serious "in a risk-management sense."

In the case of the retail trading blitz surrounding GameStop, Mr. Blitz said, "Short squeezes are really problematic if a hedge fund's long positions are also going down and the manager has to liquidate both long and short positions at the same time. It's all about risk management and prudent levels of exposure so you aren't forced to make changes and crystallize losses."

Evanston Capital managed $4.1 billion as of March 31, most of which was in hedge funds of funds.

Investment consultant Sussex Partners U.K. Ltd. attributed "the abundance of liquidity that has flooded the market" for making events like GameStop and Archegos actions more likely, said James A. Neumann, the firm's New York-based CIO, in an email.

"We have been asked by investors about the effect of the short squeezes (re: GameStop) and forced liquidations as to their effect on active portfolios," Mr. Neumann said, adding "our concern is that the environment in equities is not holding sway to say the least. Thus stock picking is difficult and the short side perhaps more dangerous than previously as there are crowded longs and shorts."

Regarding Archegos, Mr. Neumann wrote that the "sheer amount of money lost by the slower to liquidate (prime brokerages) is clearly going to have rippling effects at these organizations and in the industry. The question is will this bring about more an industrywide deleveraging that will in turn move valuations back to more fundamentally supportable levels?"

Archegos' inability to meet its margin calls in late March as the leveraged stocks it held lost value resulted in the forced liquidation of more than $20 billion in stock positions linked to the company in late March.

Credit Suisse Group AG, Zurich, Switzerland, said it expects to take a 4.4 billion Swiss francs ($4.7 billion) loss from Archegos' inability to meet margin commitments in late March.

As for institutional investor reaction to extralimital market turmoil, Verus' Mr. Toner said "it's not typical for an institutional investor to make changes in reaction to market actions like those caused by Archegos or GameStop. These time-window-sensitive events generally aren't relevant to pension funds because most have much longer intermediate- to long-term investment horizons."

Pension funds contacted for this story agreed.

David Veal, CIO of the $3.2 billion City of Austin (Texas) Employees' Retirement System, said in an email that his investment team has been watching the GameStop and Archegos situations "through our risk-management framework. We view both as symptoms of a broader trend toward greater liquidity and leverage in the financial system, which is in turn a source of systematic risk that bears watching."

Massachusetts Pension Reserves Investment Board, Boston, for example, would not change its portfolio management because of the GameStop and Archegos incidents given its long-term investment mantra, said Eric R. Nierenberg, chief strategy officer. However, as with many risk-management issues, the PRIM team is having "daily and even hourly conversations" as the investment team "studies what's going on in the markets. Taking action is another thing; long term, it's not indicative that there will be more market stresses," Mr. Nierenberg said.

MassPRIM managed $87.5 billion in defined benefit plan assets as of Feb. 28.

The Florida State Board of Administration, Tallahassee, "regularly monitors broad market dynamics and events to assess general market risk and the impact that risk may have on our specific investments, investment partners and counterparties," said Alison Romano, deputy CIO, in an email.

She added that "when we make new investments in any investment structure, we closely evaluate both the sources of investment and operational risk and the guidelines and processes by which those risks are mitigated and managed. The Archegos situation does not change our approach."

The SBA managed a total of $244 billion as of April 7, $190 billion of which was for the Florida Retirement System.