VegaPlus Commodities Hedge Fund Quit Gas, Avoided Amaranth Fate

Date: Tuesday, November 21, 2006
Author: Saijel Kishan, Bloomberg.com

(Bloomberg) -- Julian Barrowcliffe's Anglian Commodities Fund exited the natural gas market almost a year before Amaranth Advisors LLC, another hedge fund, was destroyed by plunging energy prices.

Barrowcliffe steered his $497 million fund, operated by VegaPlus Capital Partners Ltd., to metals. That helped produce a 22 percent gain in the 12 months through October, according to a letter sent to investors in the New York-based fund. The Goldman Sachs Commodity Index has lost 14 percent over the same period.

Like Amaranth, whose demise cost investors $6.5 billion after a bad bet on differences in natural gas prices, Anglian invests using a so-called relative value strategy. It attempts to profit from price discrepancies between commodities, markets, delivery dates and locations.

``We decided natural gas was rather hot to handle,'' Barrowcliffe, 44, said in an interview from the London offices of VegaPlus. ``It seemed to us that there was a huge amount of money chasing returns in the North American natural gas and power space and everyone was tripping over each other.''

Demand for commodities from China, where the economy has expanded 10 percent in each of the past five years, has helped fuel prices for oil and raw materials, giving investors such as Barrowcliffe opportunities to exploit price differences.

Metals have been the best commodity performers this year. Nickel and zinc have more than doubled while copper gained 55 percent because of production shortages and worker strikes.

``The price moves clearly helped to create the anomalies that we were targeting to exploit,'' Barrowcliffe said.

Booms and Busts

No matter how a fund chooses to balance its commodity holdings, using a relative value approach is never risk-free, said Matthew Evans, who advises companies on commodity-risk management at NERA Economic Consulting in New York.

``History tells us that commodity markets, particularly energy, are cyclical and prone to booms and busts,'' Evans said. ``We have seen that price relationships can blow up, very quickly and very decisively.''

Barrowcliffe so far is beating his declining benchmark index with consistency during some of the toughest times for commodities investors.

Anglian gained 11 percent in the third quarter, during a period when the Goldman Sachs Commodity index of 24 commodities lost investors almost 16 percent. In September, as Amaranth collapsed, Anglian returned 3.1 percent, according to the fund's investor updates, compared with an 11 percent drop for the Goldman index.

Futures

Hedge funds, which manage $1.3 trillion worldwide, are loosely regulated pools catering to wealthy investors and institutions, and invest in a range of assets to profit whether markets rise or fall. About 8,000 hedge funds trade globally, based on estimates from Hedge Fund Research Inc. in Chicago.

Like most hedge funds, VegaPlus doesn't disclose details about the weight of various holdings in its funds. The Anglian fund, which has increased 8.7 percent this year, instead tells its investors how each holding has affected returns.

Metals holdings have returned 16 percent a year since Anglian was founded in 2004. Reducing power and gas holdings helped the fund mitigate annual losses in those commodities to 5 percent, according to reports to investors. Natural gas has been the worst-performing commodity this year, plunging 60 percent as inventories rose.

Anglian also buys and sells commodity futures ranging from gold to cattle by using computers to help decide when to invest about 25 percent of the fund. Futures are contracts to buy or sell a commodity on a specific date at a preset price.

Price Discrepancies

The fund invests up to 15 percent of its capital in energy, mining and shipping companies, as well as utilities, according to the marketing documents.

As many as 24 out of 100 commodity hedge funds follow relative value strategies, according to Rian Akey, chief operating officer of Chicago-based Cole Partners LLC, which invests in commodity funds. The remainder uses a mixture of that strategy and so-called directional trading, which involves betting on prices rising or falling, he said.

Spotting relative value differences is Anglian's advantage over traders of so-called physical commodities, who are better at anticipating price movements, Barrowcliffe said. The strategy involves trading on price discrepancies, for example, between crude oils in different markets, such as West Texas Intermediate -- the U.S. benchmark -- and Brent in the North Sea.

`Looking for Wrinkles'

``We look for wrinkles in the markets,'' he said. ``I am trading against guys with storage terminals, tankers, refineries and who have government relationships. I had to find something that they didn't do. I try to find ways of trading that didn't focus on day-to-day price moves.''

Barrowcliffe himself started out in 1985 as a crude oil trader at Shell International Trading Co. and later headed global energy-trading desks at Merrill Lynch & Co. and Bank of America Corp. Born in Peterborough, U.K., he graduated from Loughborough University with a bachelor's degree in business administration and French.

The Anglian hedge fund, named to refer to ``old England,'' was started by Barrowcliffe with money from Madrid-based Vega Asset Management LLC. Vega Asset Management then spun off VegaPlus, which has $2.5 billion in assets, including the Anglian fund.

Vega Asset Management also runs Vega Select Opportunities, a hedge fund whose investors sought to pull about $400 million after it fell almost 11 percent in September. Vega Asset Management's capital now accounts for only 2 percent of the Anglian fund, according to an investor letter.

Shifting Risk

Barrowcliffe operates from what he describes as a ``room with a bunch of screens and money,'' in contrast to physical commodities traders who get access to information on underlying assets such as shipments or refineries before other traders. His five-person team includes Uday Narang, previously European president of Entergy-Koch LP, and Toly Spheeris, who co-founded Greenwich Energy Partners in 2002.

Shifts in Anglian's portfolio are indicated by the fund's reports on value at risk, or VAR, which investors use to measure the potential a company or fund may lose on a given day. For metals, the fund's VAR rose to 0.35 percent from 0.09 percent, according to a letter sent to investors. The fund's VAR in natural gas was cut to zero from 2.3 percent in the past year.

Funds that were less prescient paid the price. The plunge in gas prices also led to the closure of MotherRock LP, a $400 million New York-based hedge fund, in August. While Barrowcliffe declined to comment on failed funds such as MotherRock or Amaranth, he said that having a nose for gas trends has so far vindicated his strategy.

``You had a lot of people throwing lots of money at natural gas, drawn to the volatility,'' he said. ``There's volatility and chaos and there's a fine line between the two and if the market is teetering on the brink of chaos you might not want to be around for it.''

To contact the reporter on this story: Saijel Kishan in London at skishan@bloomberg.net