Magazine article The Spectator

Amaranth: How to Lose $6 Billion in a Fortnight

Magazine article The Spectator

Amaranth: How to Lose $6 Billion in a Fortnight

Article excerpt

Hedge funds, you read here in June, are often riskier than they are made out to be.

Putting your money into 'a fund that blows up, closes down or disappears with all your money', I suggested, is a real risk for the unwary investor. The danger, I could have written, is that you will find your money being looked after by Brian Hunter, a 32-year-old energy trader from Calgary who last month singlehandedly accounted for the largest hedgefund meltdown since records began.

In the space of two short weeks, Mr Hunter worked his way through some $6.5 billion when his complex strategy of forward bets on the price of natural gas went badly wrong, wiping out 70 per cent of the capital deployed by his hedge fund employers, Amaranth Advisors. In one day alone, Mr Hunter and his colleagues on the energy trading team lost $560 million as the price of natural gas futures plunged and they were unable to liquidate their positions fast enough to meet their margin calls and preserve their lines of credit.

The fund is now attempting to close down what remains of its operations in an orderly fashion. The energy trading positions have been sold to other market participants and what is left of its $9 billion of capital (not much) will be returned to investors. This being North America, a carrion-seeking flight of lawyers is hovering over the scene, looking to institute a legal action of some sort for the unhappy victims.

Aside from wealthy individuals, those feeling the heat from the meltdown include the San Diego county pension scheme, which has lost some $100 million, and two fund-of-hedge-funds run by Morgan Stanley and Goldman Sachs, whose allegedly sophisticated monitoring systems proved unable to spot the trouble ahead. Man Group, the quoted UK hedge fund group, also had a small exposure to Mr Hunter's trading activities.

The losses at Amaranth dwarf even those of Long Term Capital Management, the now infamous hedge fund that boasted two Nobel Prize-winning economists among its founders yet still went down in flames in 1998. It lost $4 billion in a few weeks when an even more complex series of bets on a range of financial derivative contracts proved to be less fireproof than its ultra-sophisticated risk modelling had suggested. LTCM was eventually bailed out by a consortium of leading Wall Street banks at the instigation of the Federal Reserve.

The failure of Amaranth has fortunately had few such repercussions. While there is no question that hedge funds are here to stay, the Amaranth case is an unwelcome setback for the industry at a time when its advocates are pitching hard to persuade pension funds that hedge funds are a valuable new investment class, and regulators that private investors should be allowed much broader access to these new and poorly understood investment vehicles.

Amaranth was not some fly-by-night bucket shop, but an A-list fund operating from Greenwich, Connecticut, the hedge fund capital of the world, a place cutely described at a recent industry dinner as 'New York on steroids'. Morgan Stanley and Goldman Sachs were both happy to put clients' money with Amaranth -- and if they can't spot a blow-up coming, we may well ask, what hope has anyone else?

All hedge funds trumpet the fact that they have sophisticated risk systems that allow them to pursue absolute returns -- that is, make money in both up and down markets -- in a controlled manner. …

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