Huge losses on derivative trades at Geode Capital Management force hedge-fund business shutdown: WSJ

Huge losses on derivative trades at Geode Capital Management have forced the giant investment firm to close down its hedge-fund business.

Geode manages all of Fidelity Investments’ stock-index funds, and that operation accounts for most of the firm’s $720 billion in assets. But it has also offered an array of riskier, hedge-fund strategies to wealthy clients and institutions.

Geode’s largest private fund lost about $250 million after its bets on stock-market volatility turned sour last year, people familiar with the matter said. The fund was down by some 36% by spring. The losses, and ensuing margin calls, forced the Geode Diversified Fund to liquidate other unrelated positions and led the fund’s biggest investor, Fidelity itself, to withdraw its money, the people said.

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Geode closed down the fund and exited from its broader Absolute Return business offering clients hedge-fund-like investments to focus on index investing, some of the people familiar with the matter said. The losses and closure of the hedge-fund business haven’t been reported previously.

The firm recently eliminated several jobs that served that business, the people familiar with the matter said.

Many investment firms are still paying the price of the Covid-19-driven market selloff last year. Geode’s retreat also highlights the continued heightened risks of investing through derivatives, even at otherwise growing firms.

Geode began as one of a handful of boutique managers created to invest a slice of the fortune of Fidelity’s founding Johnson family. It was spun out from Fidelity nearly two decades ago. Geode is owned by its employees, former Fidelity executives and a Johnson family trust. Abigail Johnson is chairman and chief executive of Fidelity, which was founded by her grandfather.

In recent years, Geode grew dramatically as its former parent embraced low-cost funds that track broad market benchmarks as a means to draw in new client money. Those funds carry the Fidelity brand and are sold to the Boston-based firm’s clients. But the task of buying and selling stocks to match the benchmarks’ performance falls to Geode, the funds’ subadviser.

But since its founding, Geode has continued to maintain a group of other funds that offered family offices and other institutions a menu of more complex investments.

The Geode Diversified Fund was the largest of those offerings, and its losses forced Geode executives to acknowledge the challenges of managing riskier strategies within a firm built primarily to track market benchmarks. Index managers tend to run lean operations, keeping costs low, since most of their funds charge low fees. And overseeing riskier investments can require more robust risk-management, trading and compliance needs.

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Geode Diversified, which was launched in June 2003, pursued a number of different strategies and held everything from stocks and convertible bonds to currencies and commodities. It was a solid moneymaker for years, and at its 2018 peak managed $1 billion.

The fund aimed to deliver annualized returns of 5% to 6%, people familiar with the matter said.

Stocks fell sharply last March as investors reacted to news that the coronavirus was spreading throughout the globe, posing grave threats to the economy. The Cboe Volatility Index, known as Wall Street’s fear gauge, touched a record high.

The U.S. government raced to intervene, steadying investors’ nerves with a series of programs designed to unclog markets. Stocks soon rallied, but not before the episode produced its share of casualties. Some funds, including a pair managed by Allianz Global Investors, liquidated after struggling to restructure options trades that racked up losses as volatility surged.

The Geode fund had placed roughly $80 million in derivatives that stood to profit if the market remained calm. It didn’t, and losses on the trades soon swelled.

The fund’s volatility derivatives accounted for about 10% of the fund’s assets.

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Within months of Geode Diversified’s implosion, the firm’s president and chief investment officer, Vince Gubitosi, informed Geode’s board that he was interested in retiring to pursue entrepreneurial interests. He remains an adviser to the firm.

In December, Geode picked Fidelity’s Bob Minicus as Mr. Gubitosi’s successor. A former head of equity trading, Mr. Minicus most recently led compliance, risk and business operations at Fidelity’s asset-management division.

Geode’s total assets jumped by more than $135 billion in 2020, driven by continuing demand for index funds and stock-market gains, and the money manager had its most profitable year ever.