9/23/06 NYT piece on the collapse of Amaranth Advisors hedge fund ..........................................
September 23, 2006
Betting the House and Losing Big
By JENNY ANDERSON
Less than a week before the hedge fund Amaranth Advisors told investors that it had lost billions of dollars in natural gas trades, Charles H. Winkler, the fund’s chief operating officer, was sipping Australian wine and dining at the Four Seasons restaurant with a handful of prominent hedge fund managers.
Appearing relaxed and affable that evening on Sept. 12, Mr. Winkler said that Amaranth, a $9.2 billion fund, was posting returns of more than 25 percent for the year, according to one participant.
Two days later, Mr. Winkler was at the Pierre, one of Manhattan’s most elegant hotels, talking up Amaranth to prospective investors at the Goldman Sachs Autumn Hedge Fund Conference and Educational Forum. A sort of speed-dating for capitalists, the event featured small groups of interested investors dashing from table to table, listening to managers describe, in rapid-fire fashion, their strategies before taking a few questions and moving on to the next set of investors.
Mr. Winkler was one such manager and he had much the same message as earlier in the week: Amaranth was up 25 percent, said one person who was there.
That same day, Amaranth lost $560 million on natural gas, accelerating losses the firm had suffered all week, Nicholas Maounis, the founder of Amaranth, said on a conference call yesterday.
On Sept. 14, the fund was selling parts of its portfolio — stocks, loans and bonds — to meet demands from its banks that Amaranth pay back loans it uses to trade. The next day, Amaranth called a handful of Wall Street’s top banks and invited them to its offices in Greenwich, Conn., over the weekend. The energy book and other positions were up for sale; the firm was perhaps looking for a bridge loan or equity injections.
Amaranth, one of the hottest hedge funds of recent years, was melting down.
What followed over the next few days was both unnerving and uneventful: investors watched in dismay as $6 billion evaporated and the market just blinked as if nothing had happened. Indeed, the extraordinary thing about Amaranth’s fall was how few ripples it made, unlike the near-collapse of Long-Term Capital Management in 1998. The story of Amaranth is of a firm that boasted of superior risk management and then risked everything in notoriously volatile markets. The fund did not bring the market to its knees as Long- Term Capital did; the market took down Amaranth.
“Sometimes, even the highly improbable happens,” Mr. Maounis said on a call with investors yesterday. “That is what happened in September.”
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[comments from Jon -- this line : "Sometimes, even the highly improbable happens" ... (to me) says it all (regarding the unbelievable arrogance of some of these hedge fund guys).
Every Thursday at 10:30 A.M. -- inventories of natural gas are reported.
Pretty much every week now (for months), the inventory levels have been reported as "all-time record high level" for that particular week.
The way that Amaranth's "star" natural gas trader made a lot of money (once) has been reported as follows :
He was long "way out of the money" call options on natural gas futures right before both Hurricane Katrina and Hurricane Rita (both described as "100 year storms" by some) devastated the U.S. Gulf of Mexico natural gas producing region.
(Both storms were "category 5" hurricanes when they were moving through the area filled with offshore natural gas "platforms" and under-sea pipelines).
(see :
en.wikipedia.org
and
en.wikipedia.org
for excellent information on the storms).
What seems "highly improbable" to me is that anyone ever was impressed with Amaranth's natural gas trader.]
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The debacle confirms what many in the hedge fund business know but perhaps too often ignore: Betting the house can result in enviable returns; it can also take down the house.
Yesterday, however, Mr. Maounis pledged a comeback, saying on the call that Amaranth was still in business.
“We lost a lot of our own money this month,” he said. “We lost even more of yours. We feel bad about losing our own money. We feel much worse about losing your money.” He vowed to try to win back investors faith and confidence.
Mr. Winkler of Amaranth, a well-respected former lawyer, might have been doing the best thing for investors last week: maintaining a cool facade so not to incite the kind of panic that can easily bring a financial firm down. Through a spokesman, Mr. Winkler declined to comment. But investors, unable to get their money and shell-shocked by the week’s events, are already contemplating whether the energy bet was too big, and whether the fund’s promises of effective risk management were unfounded.
“When hedge funds collapse, what you are looking for is misrepresentations made by the manager to investors that can take the form of misvaluation, misrepresentations about strategies, models or concentrations,” said Scott M. Berman, a lawyer at Friedman Kaplan Seiler & Adelman, who is representing two investors looking at potential claims against Amaranth.
The Securities and Exchange Commission has begun an investigation into whether Amaranth misled investors or financial institutions.
Amaranth may have some protection against claims that it did not stick to its strategy: it is a multi-strategy fund, meaning it had multiple strategies to make money and discretion to deploy its capital to the highest potential return areas. The diversification among strategies was a hedge in and of itself: when one market, like the stock market or convertible arbitrage market tanked, others would insulate the blow.
When Amaranth saw opportunities in natural gas, it plowed money into that market. It worked for a while, but the fund failed to get out when it could. Was it as opportunistic as multi-strategy funds should be, or was it reckless by not diversifying?
The fund’s mettle was tested in the bear market of 2002. When the major indexes fell 17 percent or more that year, Amaranth Partners, one of its flagship funds, produced returns of 11.33 percent, according to marketing materials. That trounced the average hedge fund, which fell 1.5 percent, according to Hedge Fund Research. which is based in Chicago.
During the next two years, Amaranth delivered consistently solid, if not spectacular, returns, suggesting that it was doing what hedge funds are supposed to do: hedging itself against the market’s gyrations.
The year 2005 was a hard one for many hedge funds. But Amaranth delivered returns of more than 18 percent, handily beating the dividends-included 4.91 percent return of the Standard & Poor’s index and the average hedge fund, which returned 6.16 percent.
The fund had a secret weapon in its arsenal: a 32-year-old trader named Brian Hunter. Mr. Hunter came from Deutsche Bank, where he headed the natural gas trading desk. According to a lawsuit he later filed against the bank, Mr. Hunter individually made $52 million for the bank in 2002 and $40 million in 2003.
But prices in the natural gas market collapsed in December, eliminating much of the bank’s gains and Deutsche Bank did not give him a bonus. He was moved off the desk and demoted. He sued to get his bonus. Deutsche filed a response denying most of his claims. A spokeswomen from the bank declined to comment.
Mr. Hunter was himself a hot commodity. SAC Capital, another hedge fund noted for its exceptional returns, tried to lure Mr. Hunter away in April 2005. Mr. Maounis persuaded him to stay and investors were assured he would play a significant role at the firm.
It was no secret that the fund’s returns were clearly coming from energy. Through June 30, Amaranth funds were up 20 percent or more, with energy constituting 78 percent of those returns. According to Mr. Maounis, trading-related profits from energy and commodities produced $1.26 billion in profit in 2005 and from January to August, it produced $2.17 billion — almost half of that generated from June to August.
While the June numbers looked good, investors should have been worried: the fund had fallen more than 10 percent in May because of volatility in the energy markets. Spectacular results from April and June offset the fall, but the message was clear: the fund was making big bets.
In July, Amaranth addressed these concerns in its monthly letter, promising what it had told many investors in person: It was ratcheting down the risk.
“While we are targeting a smaller allocation for natural gas in the future, we believe opportunities in the natural gas market remain attractive and continue to maintain positions where we believe fundamentals are disconnected with future prices,” the fund wrote. A number of investors said they were told the bets in energy were being reduced.
Yesterday, Mr. Maounis revisited these concerns, saying on the call that Amaranth had agreed to reduce its risk “opportunistically” rather than selling just for the sake of selling, meaning it never intended to exit the market rapidly.
Amaranth’s problem would become one all too familiar to financial firms: liquidity. Mr. Hunter bet that the spread between natural gas futures for March 2007 and April 2007 would rise. In fact, it collapsed. Mr. Hunter could not sell his positions. Others in the market saw that his bullish bet was wrong, that he was losing money and they continued to bet against the market, pushing prices lower.
“We were unable to close out the exposure in the public markets,” Mr. Maounis said.
Once the trade went sour, Amaranth was trapped: selling into a falling market, scrambling to meet margin calls from nervous lenders, stuck in a position in a market where — to use a common phrase on Wall Street — “you get your face ripped off.”
“If people see fear in the market they force the hand of the person fleeing the market,” said Charles Sanchez, vice president for energy markets at Gelber & Associates, an energy consulting firm in Houston.
In an effort to mitigate the effects of the trade, Amaranth brought in a handful of banks last weekend. The fund had to get money to meet its margin calls — loans from its banks — and it had to sell the energy trades to prevent future bloodletting. On a glorious weekend, Amaranth’s office parking lot was filled with S.U.V.’s, Mercedes and a red Ferrari with “Wall Street” on the license plate. The fund’s pantry was depleted: diet Mountain Dew and Pop Tarts were the first to go. Amaranth almost sold the trades to two bidders, but the deals collapsed.
By Tuesday, Amaranth’s banks read it the riot act: Sell the energy book or they would terminate its credit lines. That, Mr. Maounis said, might “have resulted in substantial incremental, if not total, losses to investors.”
On Wednesday morning, the energy book was sold to J. P. Morgan and Citadel Investment Group, another big hedge fund, and investors were informed that Amaranth assets had fallen 65 percent for the month and 55 percent — or $6 billion — for the year.
Investors remained confounded after yesterday’s call.
“It left a lot of unanswered questions,” said one investor. “It was about what happened. But what’s going to happen moving forward?”
In other words, will investors ever see their money?
Amaranth has tough restrictions for investors who want their money: it could freeze any redemptions in a seemingly convoluted attempt to preserve the fund’s capital.
Mr. Maounis seems determined to keep fighting. “We know we have damaged your faith and confidence in us and we are committed to doing what we can to regain them both,” he said yesterday.
For investors, that may be another risky bet.
Copyright 2006 The New York Times Company. |
