The Situation at Situational Awareness

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2:02Bloomberg Audio Studios. Podcasts. Radio. News. Basically the thing this investment firm will be will be kind of like, you know, a brain trust on AI. It's going to be all that situational awareness. This is Leopold Aschenbrenner in June 2024. Aschenbrenner is about 22 years old here. He's just left a job at OpenAI and published an essay series laying out his predictions for how AI will transform society. And he's telling his friend, the podcaster Dwarkesh Patel, about a new investment fund he's starting that's going to go all in on the technology. We're going to have the best situational awareness in the business.

2:40We're going to have way more situational business than any of the people who manage money in New York. Situational awareness is what Ashen Brenner had called his essay series. It's also what he names his hedge fund. Both are built around the same simple thesis. He believes AI is about to get a lot more powerful that will reach AGI, or Artificial General Intelligence, by as early as 2027. And he also believes that the companies building AI infrastructure are about to get a lot more valuable. I think this investment firm, it is going to just be betting on AGI. You know, betting on AGI and superintelligence before the decade is out, taking that seriously, making the bets you would make.

3:18if you took that seriously. So, you know, I think if that's wrong, you know, the firm is not going to do that well. But he tells Patel he plans on doing well. Obviously, you can't, you know, not blowing up is sort of like, you know, task number one and two or whatever. And over the next two years, situational awareness did extremely well. In the first half of this year, it posted returns of over 400%. And by the beginning of last month, it had an estimated$45 billion in assets. What is it about this 24-year-old that was so intriguing to investors? Why do they trust him with all this money? I think it's just because of what he wrote.

3:57That's Catherine Burton, who covers hedge funds for Bloomberg. He clearly had no investment training at all and clearly no risk management training at all. So I think it was just that they thought he saw something about the future and AI that they said, sure, why not throw a few bucks his way? Catherine has been tracking the rise of Ashenbrenner's fund and its unceremonious fall. Because last week, situational awareness blew up. And in the insane volatility that we've seen the last month, he was on the wrong side of things. We are seeing the pain really flow through the space. You know, we had a pullback in AI and a lot of people got hurt.

4:40By the end of July, the fund's$45 billion in assets had shrunk to an estimated$10 billion. It was a stunning reversal of fortune, brought on by the hedge fund's strategy of using a lot of borrowed money to make big bets. In other words, situational awareness was overleveraged, says Bloomberg's hedge fund reporter Hema Parmar. So there's a lot of layers of risk bundled up and leverage is especially concerning because it just magnifies everything.

5:18I'm Sarah Holder and this is The Big Take from Bloomberg News. Today on the show, the rise and fall and bailout of situational awareness. What it means for investors and whether the fund is a bellwether for the AI trade or a high-risk outlier.

5:42Catherine Burton and Hema Parmar, thanks for joining us. Kathy, what's the situational awareness secret sauce? What's supposed to set Leopold Ashenbrenner's fund apart from other hedge funds in the space? The knowledge of which companies would succeed because of AI and which would fail because of AI. I think he sold it on that he knew he could figure out which companies were going to be the winners in which we're going to be the losers. He also had quite significant private positions in AI-focused companies as well, too. And the returns. Then people started seeing the returns. That's the real thing.

6:14They saw that he was up a few hundred percent the first year and at the peak this year, up, what, 400 and some odd percent. Wow. So what kinds of investors get involved in the beginning? Yeah, no, so it's interesting because with traditional hedge funds, we typically see pensions, endowments, foundations, those sorts of institutions. This firm, Situational Awareness, gathered their capital from less likely individuals. So not the traditional sort of big institutions that write sizable checks, but rather a lot of founders and individuals. So founders of private companies like Stripe or founder of a hedge fund, D1 Capital.

6:54Dan Sondheim was an investor, according to the Wall Street Journal's report. So we see a lot more Silicon Valley types of investors writing checks than, say, a sovereign wealth fund. And what were some of those bets that situational awareness made on AI? What were some of the companies that they put the brunt of their investment into? So it was an SK Hynix was one of them, a number of other AI-focused companies. And he had a big, big stake in Anthropic. $5 billion stake. A$5 billion stake and one that everyone knew was going to pay off. And for a while, these bets were paying off, right? He was effectively posting gains that were higher than the gains of the AI companies that made up the fund.

7:33How did he accomplish that? It comes back to leverage, right? Yes. Like any hedge fund, they go to a bank. They say, can you lend us money to make our bets bigger? And they use the stocks that they own as collateral or the companies that they own as collateral. And the banks look at their returns and say, sure. A lot of big companies he traded in, you know, big liquid companies. And so they lent him money, like four or five times leverage. So that means at the peak, he could have been managing around$200 billion on his$45 billion of net assets. That amount of leverage, is it typical for the industry?

8:17Did it raise any red flags? I think it started to. Usually a long short stock fund would be more like two times would be more norm. So yes, it was a lot. When you are four or five times leveraged as situational awareness was, what happens when your assets fall, say 40 percent? So leverage basically amps up everything. It amps up the gains that you can make if you make an investment, but it can also, it will also amp up the spiraling downward pain that you'll face. And so that's why it's so risky. And then on a short bet, if you're amping up those bets, you will have to cover that bet. And there's an infinite amount of money you can lose on a short bet.

8:59The damage is a lot worse. And then the banks come to you and say, hey, we need more collateral because these things are going in the wrong direction. And then they have to come up with the cash, which means selling things in their portfolio, which sends on the prices of those things normally. and then the spiral goes faster and is bigger. Right. Whereas if you're using your own money, there's a down week. You can kind of wait it out, see maybe in two years this will pay out. But lenders are not. They're not going to be patient because it's their money. So that's the vulnerability of borrowing a lot of money.

9:33And that's what happened to this fund. At the beginning of last month, it seemed like situational awareness was in a pretty good spot. It had$45 billion worth of assets, investments from the likes of Jane Street, the Stripe co-founders, as you mentioned. But you and your team reported there were signs that Wall Street was getting anxious even in July. What were those signs? So a lot of hedge funds and broadly investors have been concerned for a while about the kind of capex spending that we're seeing when it comes to these big tech companies and their AI expenditures. So those worries have been growing.

10:04As situational awareness's prominence has grown too, you'll see a lot of funds really tracking what investment situational awareness was making and looking closely to see what stocks they were trading. In a client letter Ashton Brenner sent last week, he blamed short sellers for targeting the fund. How big of a factor were short sellers here? We have reported that apparently they weren't as big a factor as the fund said they were or suggested they were in their letter. But the mechanism for how it worked is if you wanted short, then you would go and borrow the shares and then sell them, so that pushes the price down.

10:42And so if they thought that he was going to explode, then they would keep selling the shares in the hopes that the price would go down and then they would buy them back at a cheaper price. As the markets began spiraling, as the short bets hindered the stocks of situational, concerns grew. When you look at the leverage that was placed and used, as we've been talking about, that made matters far worse for situational. Things really came to a head at the end of the month when the firm was getting these margin calls and now needs to find some cash fast. And they have a lot of money in their private book, which ideally you don't want to touch if you're a fund, if you've got$5 billion worth of Anthropic, and you have money in their public stock portfolio.

11:26And as they were trying to figure out where to get some liquidity in order to meet the margin calls, the firm had conversations about potentially selling some of their anthropic stake, which is very coveted, or selling some of their stock portfolio.

11:48So how might a 24-year-old hedge fund founder come back from a$30 billion wipeout? We'll be right back with Hema Parmar and Catherine Burton.

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13:41Just to walk through this kind of death spiral that situational awareness was in, Tech stocks were sliding. Lenders wanted out. The fund met the margin calls by liquidating stocks, which makes them lose even more value. And that's what sort of triggers the situation where Ashenbrenner needs a way out. So, Kathy, what was his plan to save the fund? It was sort of two-pronged. On the one hand, he was exploring ideas of selling some of his private companies, especially Anthropic, because that's supposed to go public later this year. So everyone knew that's a winner. And at the same time, he was talking to some hedge funds to buy a big chunk of his portfolio all in one go because that would stop the bleeding and do that at some sort of discount.

14:24So there was a fight amongst some major firms about who was going to buy it. And who ends up winning that fight. Ken Griffin was the one that ended up winning that fight. Ken Griffin runs a giant hedge fund called Citadel, which runs about$70 billion. He started it from more or less from his dorm room at Harvard. So he too was a young guy. There have been other times in history dating back to a fund blow up. There was a fund called Amaranth that he stepped in and bought their positions. He's done it several times, mostly successfully. So how did Ken Griffin and Citadel come to the table and buy this portfolio of stocks?

15:05Well, Ken likes to step in when there's distress. And so he went to the firm, or his people went to the firm, and started talking. And as I said, there were other hedge funds. Millennium had talked to them. I think Jane Street had talked to them. But Ken came in, and they negotiated, apparently, throughout the night. Ken eventually won the trade with a discount of around 10%. And what's in it for Citadel? Is it just buying these tech and AI stocks for cheap? Yeah, absolutely. And I think on the bet that once the thing was settled, they would go up. And in fact, they did go up a lot. So what is the status of situational awareness today?

15:48What's the value of the remaining private stakes that the fund has left? So situational still runs at least$10 billion. A lot of that is in the private stakes. The stocks that they have remaining that they did not sell to Citadel have likely soared because the market calmed down a lot and rallied in the wake of the news of the deal. And if we look at the Citadel side of things, their fund was basically flat before the deal. And now with this deal having snapped up this huge portfolio of stocks at a discount, the fund is up nearly 6 % for the month alone, which is more than they've made year to date so far until this deal.

16:26So it's definitely been something of a win for Citadel. Kind of a win-win. Yeah. Yes. And what did Leopold Ashenbrenner say to his investors after all this went down? How is he trying to spin this? He said, my bad, basically. He said that for the time being, they would continue without leverage. They still had a public book. He didn't say how big it was. But everything would be done with cash, shorts and longs. so he would not borrow any money in the public book, and that he still had all his private investments, and so he would carry on with that. And how do situational investors stand after the last couple of weeks?

17:09Well, it really depends when you got into the fund. If you were an early investor, if you got in even earlier this year, in January, let's say, then you should be fine. Your fund may still be up 80 % or more going back. But if you are an investor that got it in the past couple months, then you really faced the brunt of those losses. You were exposed to the declining stocks. You were exposed to selling a big chunk of a portfolio at a discount. Investors in the fund this month were down nearly 70 % in the month alone. So if you got it in the last quarter, let's say, you're not in a great position.

17:47I'm wondering what the takeaway is here because this has been a really dramatic collapse. It has sort of a OK ending, I guess. But, you know, Ashenbrenner, of course, is part of the camp of people saying AI is a great bet. It's going to pay off eventually. On the other side, you have investors like Ray Dalio who are saying AI is a bubble. How does situational awareness fit into that broader conversation about, like, how good of a bet AI is right now and whether there is bigger pain ahead for AI investors? So we're seeing something of a split between how hedge funds are looking at AI and most funds take like a side.

18:23So we do see a lot of funds that are very bullish on AI, clearly situational, CO2. There are other funds that are far more cautious. So if we look at Viking Global, they are quite intentionally stepping away from AI and not having that exposure. They've been worried about all the things we're kind of seeing this month. So while we are seeing pain sort of trickle through some of the other funds like WhaleWalk and Co2, firms that have less exposure and are taking the other side of that trade clearly are going to do a little bit better. There's also this whole part of the story, which is that situational awareness was over leveraged.

18:59So I'm wondering how much of this story is about over leveraging versus overexposure. Yeah, I mean, basically any meltdown like this is usually caused by leverage. And so probably it would have been fine if he hadn't been so leveraged. Like Emma just mentioned a company called Whale Rock, and they had a bad month, but not anything that was existential. So it's really all about the leverage and the lack of risk management. Yeah, yeah. Aaron Brown, a crypto investor, wrote for Bloomberg Opinion, and he pointed out that the simple fact that situational awareness reported a 439 percent return in July was, quote, a warning, not a triumph.

19:38He was arguing essentially that the risks of being over leveraged and overexposed are real, that those kinds of gains aren't a product of good strategy, but basically dumb luck. Yeah. Do you have any indication of how many other investors and hedge funds are out there with these kinds of high leverage AI bets? Situational feels like an outlier in that regard. We've seen the leverage story time and time again in our industry, and we've seen blowups tied to leverage. So institutions and larger players tend to really notice when we see the leverage to this degree in a concentrated portfolio. And I think that's why we've seen some cautiousness around the institutions.

20:14It's not the kind of thing we see to this degree with a lot of hedge funds that are of size. And Kathy, what is the biggest lesson here? I think they are sadly the same lesson for every blow-up, which is if your manager is using an outsized amount of leverage, then it's quite possible that you're going to have a blow-up. I mean, this time the banks were able to survive this. They all got out. They all got their money back. But we've seen times when they haven't. And actually just the importance of risk management, which, I mean, you could have a young portfolio manager, but if you don't have people that know the markets around him, then that's really an issue.

21:00At the end of last week, Aschenbrenner wrote a letter to his investors, saying, quote, We took the steps that were necessary to fight another day. He said he was determined to draw the, quote, necessary lessons from this, and make sure the fund can stay alive, even after taking a loss. Late yesterday, Hema reported that situational awareness was back at it. According to people familiar with the matter, it had put$400 million behind an unnamed, privately held company in its portfolio. The fund declined to comment.

21:54follow and review The Big Take wherever you listen to podcasts. It helps people find the show. Thanks for listening. We'll be back tomorrow.

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