Amaranth Chief Expresses "Regret"

Now Amaranth's losses are up to $6 billion.

WSJ.com - Amaranth Chief Expresses Regret In Conference Call With Investors: BY RANDALL SMITH: September 22, 2006 3:42 p.m.: Seeking to explain the loss of $6 billion this month, Amaranth Advisors founder and chief executive Nick Maounis expressed regret over the fund's ill-fated energy bet in a brief call with investors. In a 15-minute call that began at 2:00 p.m EDT today, Mr. Maounis said the past week's events "have been painful for all of us." He added, "We lost a lot of our own money this month. We lost even more of yours.... We feel bad about losing our money…and even worse about losing yours."

He said Amaranth traders had been surprised not only by adverse market moves, but also by the lack of ability to exit their losing positions. He said the fund had been subject to "a series of unusual and unpredictable events" that triggered "dramatic losses." And, he said, "the markets provided no viable means to exit."

Based in Greenwich, Conn., the hedge-fund firm is fighting for its survival after informing investors this week that it lost 65% of its assets, primarily at the hands of a 32-year-old natural gas trader. With investors fearing more losses and clamoring to withdraw their money, the fund has offloaded its energy portfolio to J.P. Morgan Chase & Co. and hedge fund Citadel Investment Group LLC and sold what it called a "a significant number" of other investments. It also is negotiating to sell at least a stake of itself to Citigroup Inc. Amaranth told investors in a Wednesday letter that the moves helped "avoid the termination of our credit" and a "forced liquidation by our creditors."...

Mr. Maounis told The Wall Street Journal on Aug. 29, less than three weeks before disclosing the losses, that Mr. Hunter's reputation for taking big, reckless bets was "greatly exaggerated." The fund had built "infrastructure around our traders so we can adequately assess risk," Mr. Maounis said then.... In today's call with investors, Amaranth CEO Nick Maounis said the fund plans to continue in business, but will eliminate energy trading from its trading strategies.

Through August, the Amaranth executive said, the fund had racked up more than $2 billion in energy and commodities trading profits. But once news of its $500 million losses "began to sweep through the markets" after September 14, he said, the "illiquidity" of the markets prompted two unsuccessful attempts to offload its natural-gas exposures in separate transactions.

Mr. Maounis said Ameranth is "evaluating" the redemption requests it has received, but gave no assurance about when such requests would be met. "We understand, of course, that the issue of redemptions is a high priority for you." And he vowed to contact investors individually over the next few weeks.

"We have no illusions about the difficulty of the road ahead," the Amaranth executive said. "We are determined to earn back your faith," he concluded, thanking listeners "for your time and patience."

Aren't these people paid extraordinarily high fees because they claim to know how asset prices and positions will react to the unexpected, and which positions in which markets can be exited easily in times of uncertainty and which cannot?

Comments

[quiz]

the "illiquidity" of the markets prompted two unsuccessful attempts to offload its natural-gas exposures in separate transactions"

It has just begun. Who wants to buy copper contracts at $3.50 per lb. Nobody. The volume in this market has been non-existent for several months.

The futures markets was taken over by speculators two years ago and the CFTC is an absolute joke. If there ever was a financial institution in need of reform, it is the commodity futures trading markets.

[Glen Bowman]

I do not agree that the futures markets were taken over by speculators two years ago. Any kind of futures trading is speculation, since humans are not gifted with the ability to know the future. There are small speculators, who make small mistakes, and there are big speculators, who can make huge mistakes.

I've traded natural gas (when the fundamentals indicate that it is extraordinary "cheap" in comparison with substitutes such as coal and crude oil), and if you're wrong, it is the trading equivalent of getting mugged. That said, I cannot fathom how anyone could be so reckless with someone else's money to lose billions in such a short amount of time. Overwhelming hubris.

[Sunlight]

Brad, in your earlier Amaranth post you calculated that their exposure to natural gas equalled about 390,000 futures contracts' worth. If you check the NYMEX website you can see that the open interest for front-month NYMEX natural gas contracts TOTALS about 110,000 contracts -- and Amaranth was dealing in "back" months that were far less liquid than this. So... to get that much exposure Amaranth had to be dealing in over the counter instruments, in addition to (or instead of) exchange traded ones.

All this reminds me of the days when I was a junk bond portfolio manager. The number of active participants in that market back then (early '90s) was in three figures somewhere -- low three figures at that after the S&Ls were forced to sell their junk by regulators -- and there was no way to get rid of anything but the most liquid stuff very quickly. Sometimes it took days to find buyers or sellers. Sometimes, more than that. Everyone had an idea, more or less, where most of the merchandise was. Bad news could take an issue down twenty points --twenty cents on the dollar -- in one day. Not an unusual occurrence. I would have to think that Amaranth faced that kind of market in trying to sell its energy instruments.

Every other institutional player would have known about its energy position and no one would dare step up to the plate to buy until Amaranth's instruments were bid down drastically. Furthermore any competitor worth its salt -- and observing fiduciary duty to its clients -- would have exploited Amaranth's distress to the max. Who could expect things to be otherwise?

When Citicorp took over Amaranth's energy portfolio one can only assume they got it for a huge discount. But Amaranth probably did better that way, than to try to wait until the market would let them out. THAT would have been a sight to behold.

[CapitalistImperialistPig]

Brad - "Aren't these people paid extraordinarily high fees because they claim to know how asset prices and positions will react to the unexpected..."

Actually, they are paid extraordinarily high fees because they have gambled successfully in the past...

[a]

Well, bud, this is exactly what capitalism is - you promise the world and get as much as the idiots are willing to let you get away with. Marx, was right, for sure - property *is* theft.

[Sonia]

Folks who expect greater returns than the market should expect greater risk. However, should pension administrators be allowed to gamble the public's money when neither the public nor the pension administrators appear to be fully informed? In the case of San Diego county someone probably made a considerable profit selling this hedge and the taxpayers will either have to pay higher taxes or have fewer public services. The alternative to pay promised pensions equal to a what a market return would yield may not be a viable alternative. Of course the county administrators may try to double the bet.

[vtcodger]

I understand that futures options have a legitimate function of allowing folks who actually produce or use a commodity to lock down the prices they will pay or receive on future sales. But the stuff discussed here has next to nothing to do with that. It looks to me like gambling pure and simple.

Gambling in the US has been designated as the domain of mobsters and Indian tribes. Shouldn't the mafia and the Indian tribes be getting a modest cut out of all this cash flow? Are the Navajo going to have to sue to get justice?

And more seriously, unless I totally misunderstand how commodities futures work, they are about as appropriate an investment for pension funds as a program of risk managed bets on NFL Monday Night Football would be. I suspect that the ancient Greeks could have figured out that speculating in commodities is a negative sum game. Total_Profits = Total_Losses - House_Cut (Transaction costs). i.e. The sum total of all the "investors" gains will be a loss equal to the sum of everybody's transaction costs. If not, Northern Europeans surely could have figured that out by the time of Leibnitz, Newton, and Descartes 400 years ago. So how is it possible that pension plan administrators with a fiduciary responsibility could be foolish enough to put money into a scheme like this? Perhaps we in the US should be paying less attention to a few thousand nut cases holed up in caves and mud huts half way across the planet (Assuming that Al Qaeda hasn't long since transferred their operation center to a Motel 6 in Kansas City). Seems to me like the incompetence and innumeracy of those we put in positions of responsibility are a likely to be a larger and more pressing problem.

[anne]

We are reminded that government pension funds supposedly aim for 8% investment returns at present, which is tricky when the long term treasury is at 4.6% but trickier still by far when investment costs are as high as hedge fund costs added to the costs of pension fund investment allocators. So, a 10% return from equity can easily take a 13% market return and beating a broad market index by 3 percentage points over time is, well, tricky.

[anne]

http://www.nytimes.com/2006/09/20/business/20pension.html?ex=1316404800&en=d1fde7e9692fc492&ei=5090&partner=rssuserland&emc=rss

September 20, 2006

Pension Fund Tallies Losses and Rethinks Its Strategy
By MARY WILLIAMS WALSH

San Diego County's pension fund was named Public Plan of the Year by a money management publication last April. Its investment returns were consistently ranked at the top of pension funds its size by Wilshire Associates, a consulting firm. It looked as if the $7.5 billion pension fund had a winning strategy for investing the retirement money of some 33,000 county workers.

Until this week.

Much of the pension fund's strategy was based on a basket of hedge funds that included Amaranth Advisors, the Connecticut hedge fund that announced Monday that it had suffered big losses in natural gas trading. Dan McAllister, the San Diego County treasurer, said yesterday that he still did not know how big the losses would be.

"We don't know whether this is just the tip of the iceberg, or just an isolated instance," said Mr. McAllister, who also sits on the pension fund's board.

He said the pension fund's investment of about $160 million with Amaranth had grown by 35 percent since last fall, and the board had been planning to take $60 million of the earnings out and invest them in yet another hedge fund.

The fund's board is meeting tomorrow, he said, but now the prospect of increased investments in hedge funds "will be the subject of a lot of discussion."

The pension fund had earned a reputation for innovation after it created an "alpha engine" in 1998, a portfolio device that used six hedge funds to earn better returns than the rest of the portfolio. Last year, the county added three more hedge funds to the mix, including Amaranth. That brought its hedge fund position to $1.3 billion, or a fifth of the total pension portfolio at that time —an unusually high percentage for a pension fund.

Now that Amaranth is in trouble, though, officials at the San Diego County fund — which is entirely separate from the San Diego city pension fund, which has been the center of a funding scandal — are being reminded that the price of big returns is big risks.

It is difficult to determine how many pension funds nationwide placed money with Amaranth, because there is no single repository of pension investment data. But a number of pension funds have begun to invest some money with hedge funds in recent years, in part to make up for losses suffered when the stock market fell in 2000 and 2001. Pension fund officials also say that they needed to diversify and considered hedge funds another asset class that they should add.

Public pension funds have also been looking for ways to meet their goal of around 8 percent annual investment returns over the long run, when more commonplace securities, like bonds, have been returning 5 or 6 percent. Governments that operate pension funds have been basing their entire budgets and tax rates on achieving pension returns of about 8 percent a year....

[anne]

The last several years, I have been struck by selected students who on graduating tell me they are flying here or there to intensive programs on hedge fund investing for family assets. Hedge fund investing, for those who have the assets, strikes me as a rage in which the funds become as dominant in markets as mutual funds. But, when a class of investors become the market or nearly so then returns will be market returns minus costs. Hedge fund assets are too large and costs are simply too high for the class to better index returns over time.

[anne]

The idea of using funds of hedge funds to diversify risk has to be self-defeating, for with sufficient diversity an investor covers enough of a hedge fund spectrum to gain an index of hedge funds. Then, all you have is an index of absurdly expensive funds to match against low cost market indexes.

[David Lloyd-Jones]

I'm impressed by the wisdom, decency and good sense shown in all the good comments above.

Meself, my reaction is summed up as just: giggle.

-dlj.

[Bernard Yomtov]

"The pension fund had earned a reputation for innovation after it created an "alpha engine" in 1998, "

Did it follow this up with the creation of a perpetual motion machine?

[sm]

Yes, the nutcases who are not in caves in Waziristan are much more dangerous.

[bartman]

The good thing about this whole affair is that futures are basically a zero-sum market, so somebody made the $6B that Amaranth lost. The only bad thing that could come out of this woud be some phony and un-needed "bailout." Thankfully, there appears to be little call for this.

[nbecker]

The hedge fun had made$2 billion for investors in the previous year. If they were paid the average fee of 20% on profits they would have earned $400 miilion. I doubt that they lost $400 million of their own money when their bets failed. The name of the game in hedge funds is to take huge risks to earn the big payoff. Its the investors who lose when the risky bets turn sour.

[Ken Houghton]

nbecker notes why there is zero credibility in:

Mr. Maounis said the past week's events "have been painful for all of us." He added, "We lost a lot of our own money this month. We lost even more of yours.... We feel bad about losing our money…and even worse about losing yours."

[shander]

I think Anne highlights the crux- a dilema of a money manager hoping to get 8% returns in a 4.6% LTT enviornment.

I see the chasing of "diversity" a bit differently, not so much an error as a case in point, but how the general concept of "diversification" can be exploited more easily by promoters taking a rake rather than borrowing at a set rate with only their own capital at risk.

On a larger scope, I really fail to GRASP, (or agree) with the notion that Equity returns are sustainable or to turn that, that "Investment opportunity is elastic to investable capital".

I'm really of the impression, and one that I don't even come close to having the economic educacation to express, that -- Our society has been for 10 years, will continue to indefinetly, has been trying to invest more money than there are viable investments for.

It seems to me that the economic growth needed on the demand side doesn't scale and isn't elastic enough to provide real returns above true service labor purchasing inflation on the Scale of the accounts dedicated to helping people retire.

I wonder if even a negative return is likely as cash has a half life beyond simple interest plus money supply growth.