Tuesday, September 19, 2006

A really bad case of gas

"Amaranth LLC, a multibillion-dollar hedge fund, is likely to be down more than $2 billion year-to-date after a fall in volatile natural gas futures last week, underscoring the risks of energy investments in a year that has seen many funds perform poorly." (Need a ticket)

Amaranth Says Funds Lost 50% This Month on Gas Trades
``We are in discussions with our prime brokers and other counterparties and are working to protect our investors while meeting the obligations of our creditors,'' Nick Maounis, the 43- year-old founder of the Greenwich, Connecticut-based firm, said in a letter to investors obtained by Bloomberg News. The funds, which had gained 26 percent through August, are down at least 35 percent for the year, or about $4.6 billion.

Amaranth, which made so-called spread trades that try to profit from price discrepancies among futures contracts, is at least the second hedge fund to be hurt by this year's tumble in natural gas. Last month, MotherRock LP, a $400 million fund run by former New York Mercantile Exchange President Robert ``Bo'' Collins, went bust after natural-gas futures fell 68 percent from their Dec. 13 peak.

``The speed with which leveraged funds can evaporate is mind boggling,'' said Mark Williams, a professor of finance and economics at Boston University specializing in energy markets.

Earlier this month, Amaranth, named for an imaginary flower that never fades, bought a portfolio of gas trades from ABN Amro Holding NV that the Dutch bank took over from MotherRock. ABN Amro had lent MotherRock $60 million, and is still owed money by the fund.

Insight Into Amaranth's Steep Loss
By Bill Feingold

This morning's news about Amaranth Advisors' catastrophic natural gas losses is probably the most shocking thing I've read in my career. Evidently the firm, one of the largest hedge-fund operators around, took a huge bath in natural gas that caused its performance to go from, according to published reports, up almost 30 percent at the end of August to possibly down more than 35 percent year-to-date.

This would be shocking enough for a small fund, but is particularly astonishing for a huge firm (assets reportedly near $10 billion) and one whose expertise has been in very different areas. One has to assume that a large part of last week's natural-gas losses were triggered by forced Amaranth sales made to meet margin calls.

Nick Maounis, who founded and runs Amaranth, is a convertible-bond guy and a very good one. He got started in the mid-1980s on a small proprietary trading desk and went to Paloma Partners, a dominant hedge-fund family specializing in convertibles, several years later. In 2000 he spun off Amaranth from Paloma and had grown the firm spectacularly up until this remarkable setback. Maounis is known, among other things, for the annual Final-Four party he holds at his Greenwich mansion.

Understanding Risks in Hedge Funds
By Bill Feingold

Most hedge funds (and I cannot prove this, given how opaque the market is, but I do speak from experience) try to generate moderate, steady returns. They seek to do so while having as little correlation as possible to the biggest and most liquid markets (e.g. the S&P 500, Treasury bonds). The theory is that it's extremely easy nowadays to gain exposure to those markets, and the only real service a hedge fund can provide is either to add a lot more return for relatively little incremental risk, or to provide comparable returns to the big liquid markets with substantially less risk. Risk is typically defined as variability in month-over-month or year-over-year returns, which is often referred to as "volatility."

Now, it's certainly true that some hedge funds actively seek greater risk than you find in the S&P 500 or Treasurys, because they think the returns they can generate justify it. Portfolio theory argues that if you can put together a bunch of investments whose returns are uncorrelated with one another, it may not matter if taken individually they are quite risky. It's the classic case of the whole being much better than the sum of the parts.

It's the job of managers of both individual portfolios and managers of multiple portfolios run by a group of managers, to mix risk and return. You mix those two and end up with a finished product with the greatest possible return for a given risk level. Academics refer to the portfolio combinations that should yield the maximum return for each given level of risk as the "efficient frontier." If the average finance professor on CNBC doesn't remind you of John Wayne, don't worry, you're not alone.

Meet Brian Hunter, Head of Amaranth Energy Trading Desk
So who is this Brian Hunter we mentioned in the previous item about the huge losses at Amaranth Advisers? We haven’t been able to track down a picture of him yet but we’ve collected some details on young man who came to head his fund’s energy trading desk at the age of thirty-two.

Earlier this year, Trader Magazine ranked him at 29 in its list of top one hundred traders. He’s said to have made $800 million for the fund in 2005—much of it from the skyrocketing price of natural gas in the wake of hurricane Katrina—and was paid somewhere between $75 and $100 million. When he decided he wanted to leave New York for his native Calgary, Amaranth set up an office there for his team.

Hunter’s role in the losses his fund expects to suffer as it unwinds its natural gas position is not yet known. One source familiar with the market for energy trades told DealBreaker he believed Hunter had made trades this year similar to his winning 2005 bets and got caught out when 2006 produced a much calmer hurricane season and new oil discoveries in the Gulf of Mexico.

Amaranth's Risky Business
By Matthew Goldstein

It appears risk management went out the window at Amaranth, the giant hedge fund that lost $4 billion on a bad bet on natural gas prices.

The six-year-old hedge fund's big gamble that natural gas prices would keep rising paid off for much of the summer. At one point, the Connecticut-based fund was up 20% for the year -- boosting its assets under management at one point to a little over $9 billion.

But what made Amaranth's gamble so disastrous is that it borrowed heavily from its brokers to bet on the spread between natural gas contracts. By one estimate, for every dollar of its own money that Amaranth put down, it used $5 in so-called leverage.

Gambling with borrowed money may not have been the only risky thing Amaranth was doing. There's speculation on Wall Street that the hedge fund, led by Nick Mauonis, may have been trying to corner the market in long contracts on natural gas futures.

Michael Greenberger, a professor at the University of Maryland Law School and former director of the division of trading and markets at the Commodity Futures Trading Commission, says he's heard that Amaranth made many of its trades on the over-the-counter market -- away from the New York Mercantile Exchange, where trades could have been monitored by regulators. Greenberger says the natural gas market has become a pure speculators' market subject to potential manipulation.

He says he wouldn't be surprised if the Amaranth debacle spurs a closer look into the high-risk, speculative trading going in the natural gas market.

"I don't know if Amaranth is going to be the last straw," says Greenberger. "But Amaranth is not going to be the last problem."

Indeed, there's speculation that Amaranth's big move into long contracts on natural gas hastened the demise of MotherRock, a $450 million hedge fund that went bust in July after being overly short on natural gas prices.

Traders say Amaranth's big bet on gas prices going up may have squeezed MotherRock, which was betting on a sharp decline.

Hmmmmm... Dueling hedge funds take out both the longs (Amaranth) and the shorts (MotherRock). Risque business, indeed.


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