As Wall Street still clamors to untangle the levered Archegos bets on ViacomCBS (VIAC) and other stocks, lessons are emerging that ring true for both institutional and retail investors. However, while Wall Street lives on to trade another day, the retail crowd may not be as fortunate.
It doesn’t matter if it’s a retail trader buying call options on GameStop or an institution borrowing money from a prime broker to help fund a position. If a trade is levered 10 times, it only takes a 10% loss to wipe out.
On the Archegos matter, Bill Smead, chief investment officer of Smead Capital Management, writes, “Recent studies show that most investors have never been so concentrated in over-crowded ownership of popular tech-related securities. These managers are trying to justify over-paying for common stocks based on historically and unsustainably low interest rates. They are disrespectful of the history of forward returns, unafraid of antitrust enforcement and scrambling to support their compensation structure which favors leverage and risk!”
This speaks to the heart of the difference between institutional and retail traders: Wall Street rewards risk-taking even if that very same risk-taking historically ended up blowing out a fund or two. A few terrible decisions aren’t necessarily career ending. Contrastingly, retail traders bear the brunt of their own decisions — both the good and the bad.
The greatest hedge fund meltdown perhaps of all time was Long Term Capital Management, which in 1998 required a bailout from the big investment banks orchestrated by none other than the New York Federal Reserve (although the Fed didn’t supply any of the bailout funds). Long Term’s principle, John Meriwether went on to start another hedge fund — and subsequently crashed that one too. Then he started another one.
A portfolio manager who demonstrates ability to generate returns (despite crashing and burning) usually gets at least a second chance. Retail traders must bear their own losses. If they blow out their account and can’t replenish it, they’re done.
Live to trade another day
It seems Credit Suisse was trying to play the same role the New York Fed played with Long Term. The bank wanted to sit all the other Archegos exposed brokerage houses down at a table and discuss options. Credit Suisse wanted to, along with the other so-called prime brokers, hash out a strategy to sell the collateral they had seized from Archegos and (hopefully) avoid a fire sale.
Bloomberg writes, “Underscoring the chaos of an escalating situation, representatives from Credit Suisse Group AG floated a suggestion as they met last week to confront the reality of such an exceptional margin call and consider ways to mitigate the damage: Maybe wait to see if his stocks recover? Viacom, some noted, seemed artificially low after its run-up past $100 just two days earlier.”
Nice idea. But Goldman Sachs and Morgan Stanley simply offloaded billions worth of positions ahead of that meeting. Adults in the room at Credit Suisse ought to have known better. It gets back to the perverse incentive structure, which encourages recklessness among the weak-willed. “As is so often — not always! — the case, the market rewarded absolute unsentimental ruthlessness here,” says Bloomberg’s Matt Levine.
One piece of good news: Amid the Archegos margin calls and backstabbing by Wall Street banks, ultimately the trades were wound down without posing systemic risk. Taxpayers weren’t on the hook. Heads are rolling at Credit Suisse, while banks and hedge funds are reassessing their relationships and risk procedures.
But retail traders sitting on losses or bleeding their accounts dry with expensive options positions must deal with the volatility in the market without losing their shirts. Of the incredible gyrations that markets have endured in 2021, including the GameStop maelstrom, Smead told Yahoo Finance, “The abuse for this stuff is going to cause a whole generation of people to not want to participate in the stock, which is exactly what happens every 30 years. We have to go through this.”
Let’s hope retail traders learn some hard-fought lessons and stick around.
Jared Blikre is an anchor and reporter focused on the markets on Yahoo Finance Live. Follow him @SPYJared