On Wall Street credit is the most important aspect in operations. The greater amount of credit, the greater the ability to leverage trading and the greater profits roll in. Unfortunately, every once in a while the opposite is true, if there is greater leverage and the trades go the other way, margin requirements have to be filled. The first thing to do is use cash, then stocks are sold and then higher interest rate bond financing is needed.
In the world of billionaires, if an investment manager only looks after one family money, very few regulations have to be followed because the family is expected to perform oversight of the investment managers. When investment managers have a great deal of success with a strategy, the oversight is less. When money is lost, the cry for oversight or regulations are heard.
In an article by Judy Babu of Reuters during the last days of March, a family holding company called Archegos Capital Management needed to sell large blocks of stock which had the affect of lowering the price of the shares. Companies such as ViacomCBS, Discovery Communications, Baidu, Tencent Music Entertainment were affected.
The investment banks have a division called prime brokers which deals with hedge funds and block trades. In that world, when one prime broker moves stock at a lower price to get the shares off their books or limit losses, the other prime brokers are trying to do the same thing. In the Archeogos case Goldman Sachs and Morgan Stanley were able to sell billions of dollars of stock leaving Deutsche Bank, Credit Suisse, Nourma Securities and others needing to sell more at lower prices. The root of the problem was leverage and a successful strategy by the investment manager. Bill Wang had success and his style was very active which means a generated a great deal of fees, in the world of fees he is a investment whale. Given the size of his portfolio, (Mr. Wang owned 100 million shares in ViacomCBS) investment banks were willing to sell synthetic products, however because they have a very specific purpose the products themselves are concentrated and illiquid which means when Mr. Wang is leveraged 8:1 or 20:1 there is very little room for error. The reason Mr. Wang used synthetic products or Total Return Swaps is to keep his trading less public than other investment managers. Hedge Funds need to file 13F reports to the Securities and Exchange Regulators and all over Wall Street when they are published, people review them to see what strategies successful funds are doing or what stocks they own. When the reports are published – analysts, reporters and people on You Tube will report what the top funds are doing. Then you can do something or nothing, one of the most reviewed 13F report is what is Berkshire Hathaway doing?
The issue for the Investment Banks should have been risk/reward or risk management – what is the downside and how much risk is on the books? While generating fees is wonderful, if the firm loses money was it worth it? In one report suggested the Prime Brokers had met and a strategy of an orderly exit, which meant few losses. However losses by Mr. Wang meant the strategy was null and void and the Prime Brokers were on their on. Goldman and Morgan Stanley acted first to limit losses.
Linking to dividend paying stocks, leverage is one of those double edged swords, it is possible to make more money, it is also possible to lose more money. If you buy dividend producing stocks, you are buying for the dividend and not the capital gain, although if the capital gain comes you welcome it, which tends to mean you are buying the stocks in a non leveraged position. While the price of the stock will move up and down, if you are more concerned with the ability to pay dividends, there will very few sleepless nights.
There are more questions than answers, till the next time – to raising questions.