Family Office

Archegos Fell Short Of Being Hedge Fund Or Family Office - Commentary

Patrick Ghali, 20 May 2021

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The failed business - structured as a family office - which caused big losses for certain banks, continues to stir debate about the accuracy of the terms used to describe actors in today's financial markets.

A lot of commentary has already been written and spoken about the Archegos Capital affair. This New York-based hedge fund, structured as a family office, has imploded, and caused heavy losses for certain banks such as Credit Suisse and Nomura. The fallout has rattled regulators. One prominent US regulator wants tighter controls on family offices. This has provoked pushback from people arguing that such regulatory extension will miss the real sources of trouble, such as banks’ inept risk management, or the individuals inside family offices making the trades. It is also argued that as they don’t take in third-party funds, family offices – unless they pose systemic risks – should carry the can for their mistakes. Markets sometimes require harsh lessons, if only to warn others about what can go wrong. 

These are complex issues, and debate is far from settled. In this article, Patrick Ghali, co-founder of Sussex Partners, a hedge fund advisory business, talks about why accurate definitions and clear understanding are so important in the investments world.

The editors of this news service thank Patrick for his contribution to debate; as ever, the usual editorial disclaimers apply. We urge people to get into the debate. Email tom.burroughes@wealthbriefing.com and jackie.bennion@clearviewpublishing.com

A lot of attention has recently been garnered by the events surrounding Archegos Capital. Different publications have referred to it as either a hedge fund or a family office, and to some this has created the impression that what has happened at Archegos is commonplace in the market and representative of other firms, and that these sectors are dominated by swashbuckling buccaneers. Taking a closer look at what a typical hedge fund or family office looks like may therefore be instructive.

It has been our contention from the beginning of this story, that Archegos is neither a hedge fund, nor representative of a typical family office. Let’s start with the hedge fund comparison. While it is true that Archegos seems to have been running an “unconstrained” strategy, and that one could assert that this is therefore similar to a hedge fund in that sense, a fundamentally important factor in any successful hedge fund strategy is risk management. Investors often start their analysis of a manager not on the returns but on the risk side of the equation for that exact reason. 

Being able to avoid permanent loss of capital, and situations that force a fund to realise losses at the most inopportune time are key aspects that investors want to understand. Concentration risk, and excessive leverage are ingredients that don’t go well together, and that typically would not be accepted by institutional investors when looking for stewards of their money. The purported levels of concentration and leverage are not in line with what is usually seen in common hedge fund strategies, and it is very likely that, had Archegos been open to outside investments, it would not have been able to attract sophisticated institutional capital for the reasons above. Many consultants and advisors would not have approved a fund with these attributes for investment by their clients. It therefore seems to be an unfair comparison to equate Archegos with a hedge fund, as it fell foul of one of the most fundamental aspects of hedge funds which is good risk management. 

As to the comparison with a typical family office, it should be observed that there is no such thing as a typical family office, just as there is no such thing as a typical family. Every family office is different in terms of the source of their wealth, and the objectives they try to achieve. In most cases, family offices have been set up in order to provide multi-generational wealth management and wealth preservation. Family offices may be tasked with providing diversification away from a concentrated holding in an operating business that may be the source of a family’s wealth, or to manage assets from the sale of a business. 

Family offices often consider themselves to be stewards of future generations’ wealth and their main concern often is to maintain purchasing power for the family over very long periods of time and for many generations to come. They are typically aiming to “stay wealthy” rather than to “get wealthy.” Running a strategy that allows a family to lose all their wealth in one afternoon is therefore not how most of them manage their investments. 

Some commentators have countered that supposedly many hedge fund managers have turned their businesses into family offices recently. While it is true that some very successful hedge fund managers have indeed chosen to go down that path, and that family offices with that pedigree may be more trading oriented, this still doesn’t mean that they would be running excessively leveraged or concentrated portfolios. The reason why these hedge fund managers have been able to accumulate enough wealth to set up their own family offices is because they have not only been able to generate attractive returns, but because they have also been good risk managers. It is therefore unlikely that they would use their hard earned wealth to put on highly risky bets on which they could lose it all in short order.

The last point that keeps being raised is the one of registration for family offices. Here again, it is rather hard to generalise. Current registration depends on the type of family office and on the jurisdiction on which it is based. Many family offices that manage money for more than one family (multi-family offices) already need to be regulated in order to be able to do so. We have also seen instances of single family offices deciding to get licensed because it facilitates their interactions with counterparties significantly and brings operational benefits to them. It is therefore also inaccurate to state that all family offices are unregulated. Furthermore, it is questionable whether registration would have prevented what happened. Strengthening risk management procedures at the prime broker level would likely have been the better tool to avoid a situation such as this from happening in the first place. 

Calling Archegos a hedge fund or a family office disparages both and sows confusion and mistrust. However described, the reality is that it fell short of being either. Hedge funds and family offices each play valuable roles in the overall financial markets - the former as a source for uncorrelated returns delivering balance to investor portfolios, and the latter as a diversified source of capital. The financial markets and investors need them both.

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