Amaranth, Eight Years After LTCM, Shows Lapse in Risk Control

Date: Tuesday, September 19, 2006
Author: Saijel Kishan, Bloomberg.com

(Bloomberg) -- Eight years after the collapse of Long-Term Capital Management LP, the hedge fund industry is still struggling to manage trading risks.

Amaranth Advisors LLC of Greenwich, Connecticut, yesterday told investors it lost about $4.6 billion following wrong-way bets on natural gas prices. MotherRock LP, a $400 million fund, collapsed because of energy trades. Ospraie Management LLC started liquidating a $250 million fund in June after losses in the commodities markets.

As more than $20 billion poured into funds that invest in energy and commodities this year, commodities prices fell. The Reuters-Jefferies CRB Price Index, a market benchmark for everything from oil and natural gas to copper and sugar, dropped 16 percent from its May record, the biggest decline in at least two decades.

``I expect to see more losses, but probably not at the same magnitude as Amaranth,'' said Peter Fusaro, co-founder of New York-based Energy Hedge Fund Center, which advises companies on energy trading strategies. ``There are too many managers out there getting too much money because of the recent interest in commodities, and their risk-control systems aren't adequate enough to cope with the inflows.''

Amaranth's trading losses are among the biggest since 1998, when Greenwich-based Long-Term Capital lost $4 billion investing in government bonds. Long-Term Capital, founded by former Salomon Brothers Inc. Vice Chairman John Meriwether, received $3.5 billion from lenders after the Federal Reserve organized a bailout.

Hunter's Bets

The trader responsible for Amaranth's natural-gas bets is Brian Hunter, co-head of the firm's global energy and commodities unit. As of June 30, energy trades accounted for about half the capital of the Amaranth funds.

Hunter, 32, who works in Calgary, about 2,500 miles from Amaranth's headquarters in Greenwich, couldn't be reached yesterday after Amaranth founder Nick Maounis sent a letter to investors notifying them of the losses.

Amaranth is ``working to protect our investors while meeting the obligations of our creditors,'' Maounis, 43, said in the letter. The firm's two main funds, which had gained 26 percent through August, were down at least 35 percent this year as of yesterday.

Amaranth's losses piled up as gas prices dropped 12 percent last week after the U.S. Energy Department reported stockpiles climbed above last year's levels.

`Directional Traders'

Natural gas traders have been wagering that the difference between futures prices for natural gas delivered during the Northern Hemisphere's summer and winter months would get larger, a trend that's held since at least the beginning of 2004. Futures are contracts to buy or sell a commodity on a specific date at a preset price.

Instead, the spread collapsed. The difference in price between the March 2007 and April 2007 contracts for natural gas peaked in July at $2.60. That shrunk to $1.15 by the end of last week. The spread between the two was 83 cents today on the New York Mercantile Exchange.

Natural gas futures are the worst-performing commodity this year, slumping 51 percent. Soybean meal futures in Chicago have fallen 16 percent and cocoa prices in London are down 15 percent.

``The problem is everyone was bullish, so directional traders lost money,'' said Marcel Melis, founder of Energy Capital Management BV, an Amsterdam-based hedge fund that plans to start trading Oct. 1.

The average hedge fund gained 9.2 percent last year after fees, slightly ahead of 2004's 9 percent and well below the average annual return of 16 percent compiled during the 1990s, Hedge Fund Research Inc. reported. The average fund was up 5.8 percent this year as of July 31.

Fund Closings

More than 500 hedge funds shut in the past two years, mainly because of bad investment performance, according to data compiled by Chicago-based Hedge Fund Research. The funds are private pools of capital that allow managers to participate substantially in the gains on investments made on behalf of clients.

A U.S. Securities and Exchange Commission rule that tightened oversight of the $1.2 trillion industry was struck down by a federal appeals court in June, leaving the agency without the power to conduct random inspections of many funds.

Hedge fund managers at Aeneas Capital Management LP are under investigation by regulators in the U.S. and Malaysia after holdings in Malaysian stocks led to losses of about 60 percent in one of its funds, three people with knowledge of the matter said last week.

Losses at managers such as Aeneas Capital and Amaranth ``may result in investors looking more closely at what they should have been looking at in the first place: sound risk-management systems,'' said Aljoscha Haesen, who helps manage about $40 million at London-based Forsyth Partners Ltd., which invests in commodity funds.

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