Family Offices have been in the press recently following the frenzied fire sale that wiped over $35 billion off global stocks. It was triggered when Goldman Sachs and Morgan Stanley started ‘dumping’ multibillion-dollar positions in US and Chinese stocks.
It later transpired that Archegos Capital a family office managing the wealth of former hedge fund manager Bill Hwang had failed a ‘margin call’ – a demand to put up more collateral against its trades. Goldman Sachs and Morgan Stanley were spooked and started to sell all the investments Archegos had with them and came out unscathed leaving Credit Suisse and Nomura to take the full effect of the downfall Both banks have admitted that they would probably lose billions of dollars which could wipe out their profits for the year.
The Financial Times says ‘Regulators are already bristling. Dan Berkovitz at the US Commodity Trading Commission said oversight of family offices ‘must be strengthened’ noting that they ‘can wreak havoc on our financial markets’’
True - but I am not sure that is the right way to go
According to business school Insead last year, the number of single-family offices had grown by 38% between 2017 and 2019, to reach more than 7,000. On average Family Offices each have $1.6billion under management, which often includes art collections, yachts and private jets. Most will have more than one office in strategic locations such as Singapore, Luxembourg and London.
Assets under management at family offices stood at some $5.9trillion in 2019, whereas the hedge fund industry has only $3.6 trillion. But whereas the hedge fund industry is regulated, Family Offices are not – they can do just about what they like!!!
Family Offices like Hedge Funds can use leverage – which means they can borrow money to invest. The logic is simple enough, if you put £100 deposit to buy a £1,000 investment which goes up to £1,200 your £100 has made £200 which is a return of 200%, but if the £1,000 goes down by £200 your investment of £100 is wiped out
Archegos was able to build huge positions through ‘total return swaps’. These are ‘derivatives’ – which means the value is in the contract with the bank which pays out if an investment goes up or down – a bit like informed gambling - but does not affect the investment itself which remains unaffected.
The borrower keeps an eye on his lending and if he suspects the deals are getting too risky – can ask for a larger deposit – which is a ‘margin call’. In the case of Archegos, it failed to meet the margin call, Goldman Sachs and Morgan Stanley got spooked and set about liquidating all the investments it held on behalf of Archegos to cover their exposure, but Credit Suisse and Nomura were not so lucky and took the full effect of the downturn.
Most family offices I have worked with are nothing like Archegos. They are set up by Founders of business empires which either continue to run the business and the family assets or who have sold their business and want to control the investments of the family rather than to entrust them to banks or asset managers. Most family offices are risk averse – which means the fear of losing money far outweighs the benefit of making more – their returns may not be stellar, but they are not at high risk of losing money either.
There are some Family Offices which were not formed to manage the profits of a business but have come out of former hedge funds – Archegos was one of these later types.
Bill Hwang was a fund manager with the legendary Tiger Management hedge fund, but in 2012 he was convicted of insider trading.
Undeterred he bounced back to form Archegos and despite his well-documented ‘dodgy’ past, many big banks were keen to loan him money as ‘prime brokers’.
All financial institutions are obliged to ‘know their client’ and would have on record Bill Hwang’s past record, but despite this big names in the banking world were keen to lend him money and continued to do so even when the deals he was doing looked extreme.
Archegos was a frequent trader Hwang was a very profitable client – but its activities were excessive for a hedge fund, let alone a family office keen to preserve capital, This should have triggered alarm bells -and something should have been done to stop him.
In my opinion therefore the regulation of family offices is not necessary. There are already obligations on financial institutions to ‘know their client’ but what may be necessary is to police what large banking institutions are doing when profitable clients are taking on too much risk.
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