Another NYT piece (9/29/06) on collapse of hedge fund Amaranth Advisors .................................
September 29, 2006
Insider
Betting on the Weather and Taking an Ice-Cold Bath
By JENNY ANDERSON
There’s a lot of talk about lessons learned from the evaporation of $6 billion of capital at Amaranth Advisors in Greenwich, Conn.
The most obvious one is: Don’t put all your eggs in one basket. Amaranth was a multistrategy fund that was acting like an energy and commodities fund. When it bet big on natural gas and lost, it was apparent that it was neither multistrategy nor particularly well hedged.
The slightly more complex lesson is that risk management can look good, sound good and still be dangerously weak. In a call with investors last week, Nicholas Maounis, the founder of Amaranth, told his investors that Amaranth’s risk management gurus thought it was “highly remote” that Amaranth would lose its shirt on the natural gas bet. He defended the “full-time, well-credentialed and experienced risk professionals” who were modeling and monitoring the energy portfolio’s risks.
“Sometimes, even the highly improbable happens,” he said. “That is what happened in September.”
Improbable, perhaps. But also highly anticipated, making the scope of some of the bets and the fund’s lack of controls around it confounding.
Amaranth’s energy desk, run by a young, brash trader named Brian Hunter, bet on a number of different things, including certain “spread trades” in the natural gas market.
Among the spread trades Amaranth placed was a bullish one on the difference between the March and April futures price of natural gas for both 2007 and 2008.
The bet was that the spread between the two months would widen. The rationale was reasonable: Amaranth anticipated the price of the March contract would rise (March is the last month of winter and higher demand would result in higher prices) and April prices would fall, as summer approached and more supply led to lower prices.
The spread between the March and April futures contracts for 2007 was $2.49 during the last week of August. By Sept. 15, it fell to $1.15, more recently tumbling to 58 cents. Contracts for March-April bets in 2008 and 2009 — contracts that tend to be less volatile — also widened, wreaking havoc on the fund’s portfolio.
The reasoning was straightforward: inventories of natural gas were strong, sending futures prices down and souring Amaranth’s bet.
Such precipitous drops are not without precedent. Anyone making a similar bet for the 2006 spread — betting that the March 2006-April 2006 spread would widen — witnessed a far more devastating fall earlier this year. On Dec. 8, 2005, the spread was $3.48. But when the market realized that demand was low — driven lower in part because of the high prices that resulted from Hurricanes Katrina and Rita — and the winter was expected to be quite mild, the spread collapsed. By January 5, 2006, it was 30 cents, a 91 percent drop.
So wild price movements do not seem to be a rare event. Certainly prices for the 2007 spread, among the bets Amaranth made, had been on a tear in the not too distant past. From the last week of July to the last week in September 2005, for example, the price rose 118 percent. Of course if a trade can spike, is it so shocking that it can also take a nose dive?
“As a one-day move it was very surprising,” said Hilary F. Till, a principal at Premia Capital. “But that the spreads would come in is not an unusual event. You could look at where the spreads traded pre-2004 and see that they are quite wide compared to historical levels.”
Philip K. Verleger, an energy expert based in Apsen, Colo., said he believed that Amaranth bet on weather: extreme weather events would cause shortages of natural gas to support the unusually wide spread. “Certainly the spread’s historical performance did not justify the trade,” he wrote in a newsletter. “The only possible explanation is Amaranth expected hurricanes to disrupt natural gas production and cause a temporary aberration in the price spread.”
Other energy analysts also anticipated the market’s moves.
“Given the bearish conditions, there was a more than 50 percent likelihood this would happen,” said Kent Bayazitoglu, head quantitative analyst with Gelber & Associates, an energy consulting firm. “The question was when.”
Knowing that even meteorologists can get the weather wrong, what would motivate a young trader in Canada and his bosses to be certain enough to make bets so big that adverse moves — even improbable ones — would bring a fund to its knees?
Well, greed, apparently — that, combined with inadequate risk controls. Reading between the well-lawyered lines from Mr. Maounis’s conference call with investors offers one clue. Mr. Maounis said the fund viewed the probability of the market’s moving the way it did as “highly remote.”
“In addition, the trading desk expressed confidence that we would be able to achieve our position-reduction goals economically and expeditiously.” In other words, the desk taking the risks said the risks were not too risky.
Trading in illiquid and volatile markets is an excellent way to make money. But it involves quixotic risks. “You can’t model God,” said one hedge fund manager puzzled by the size of Amaranth’s bet.
And if you do, you better not bet the house on it.
Copyright 2006 The New York Times Company. |
