The exposure Archegos had to Viacom and other stocks really does open a Pandora's box worth of issues surrounding the use of total return swaps in today's global equity markets, says Joseph Cordahi.
Viacom, the stock that Bill Hwang's fund was most exposed to, is not exactly a mainstream technology stock like a Microsoft or Amazon.
What the downfall of Archegos has shown is that investment managers have to, at the very least, have some insight into what is behind complex derivatives if they are to harbour any hope of calculating the potential risk underpinning bigger and more liquid stocks in the future.
The trouble is that, Archegos was not technically a hedge fund, it was a family office. Therefore, their disclosure requirements were less transparent by definition."
What was interesting about Archegos is that there were no obvious investment fundamentals to indicate why the Viacom stock was pushing north of $100 per share, before it then started to move sharply in the opposite direction.
Now the reason market participants like to use these total return swaps is to give them anonymity in order to get in and out of positions quickly without moving the stock drastically if the position was made public.
Why do they want to do this? Well, hedge funds in particular are starting to work out that when you disclose a certain type of large position, the wider market catches onto what you are doing.
Therefore, hedge fund managers have found creative ways through these swaps which enables them not to disclose their exact position to protect themselves from a Melvin Capital GameStop situation that took place earlier this year.
The trouble is that, Archegos was not technically a hedge fund, it was a family office. Therefore, their disclosure requirements were less transparent by definition.
This presents a real problem as with instruments as complex as the total return swaps deployed, investment managers need to be able to understand the underlying security behind the swap to calculate the risk.
Regardless of whether it is a single stock, or a basket of securities, a much more granular insight into exactly what is behind the derivative is required.
This is because complex investment vehicles, with new instrument or trade-related data information, need to be quickly defined within custom-made templates before they can be incorporated into a global investment process.
Archegos, who clearly had no such system in place, represents a much needed a wake-up call to the wider investment management industry.
As the SEC continues to look over rules around disclosure and transparency, fund managers also need to start assessing the situation.
It is no good relying on an SEC filing, this does not paint a full picture in terms of what may be underpinning the stock.
The reality is that, in an investment world that has never been more complex, investors desperately need regular insight about a fund's investment approach.
By Joseph Cordahi, Product Strategy Director at NeoXam