Amaranth Advisors has violated a cardinal rule of investing: Never make a trade that could put you out of business.
The Greenwich, Conn.-based hedge fund was scrambling today to sell holdings after a wrong-way wager on natural gas cost it roughly half of its $9.5 billion portfolio.
Amaranth's brokers -- including Goldman Sachs and other big financial firms -– stepped in to help the hedge fund raise cash by liquidating some of its assets.
Amaranth made about $1 billion last year, when energy prices were going up. But its energy desk failed to predict the extent of the recent downturn in natural gas prices, the fund told investors in a letter that went out on Monday.
The trade that led to the huge loss was attributed to 32-year-old Brian Hunter, an experienced energy trader who headed Amaranth's energy desk for the past five months. His trades brought in $800 million for the firm last year, and Hunter pocketed at least $75 million in compensation, according to Trader Monthly magazine.
Hunter's downturn was as sudden as it was shocking. He was up about $2 billion as recently as the end of August, The Wall Street Journal reports. Then Hunter's trades lost $5 billion in about a week.
Hunter thrived on volatility, reaping profits on price declines and surges alike, the Journal reports. But late last week, Hunter watched with growing alarm as gas prices took a steep dive, particularly in futures contracts for delivery of gas for this coming winter.
"(Hunter) thought he knew what the market was doing," says Journal editor Phil Kuntz, who worked on the newspaper's coverage of the Amaranth debacle. "The commodities market is very, very volatile. You make a lot of money very, very quickly but you can lose a lot of money very quickly," Kuntz adds. "(Hunter) made about $1 billion in April. He lost a bunch of money in May, then he made a bunch of money back. He had a great August -– by the end of August (the Amaranth trading desk) was up upwards of 20% (year to date) but then they took a big hit in the course of a week in September."
Fund investors feeling the sting of Amaranth's recent losses include Morgan Stanley, Credit Suisse, pension funds and individual investors.
Amaranth is the second hedge fund in the last month to be whipsawed by the volatile energy markets. MotherRock, a $400 million fund run by former New York Mercantile Exchange President Bo Collins, lost all of its investors' capital last month when it mistimed the natural gas markets.
Wall Street was waiting to see where the next shoe would drop.
"You're going to see (a ripple effect) in September results, when the funds of (hedge) funds start reporting results," says the Wall Street Journal's Kuntz. "You're going to see it in other institutional investors, like pension funds. They're going to be taking huge hits from this."
"There are also winners on the other side of it," Kuntz says. "Some of the big Wall Street firms were taking essentially the opposite side -– not of specific bets that Brian Hunter and Amaranth were taking but taking basically the opposite view of the market. They made a lot of money in the last month."
Hedge-fund insiders say the sheer number of competitors chasing returns can lead some traders to assume outsized risks. "It's hard to find ideas that aren't picked over, and harder to get real returns and differentiate yourself," says hedge-fund manager Steve Cohen. "We're entering into a new environment. The days of big returns are gone."
Other insiders point to what they see as a lack of talent running some of the 7,000 hedge funds in the United States. "There's $1 trillion, and possibly $1.5 trillion, in capital in hedge funds, and there's certainly not enough talent to shepherd that capital adequately, and certainly not talent to justify the fees," says Antoine Bernheim, president of Dome Capital Management, which advises European institutional and private investors on their hedge fund portfolios. Bernheim also publishes Hedge Fund News, a quarterly newsletter that tracks the industry.
This week's implosion was not the first for Hunter, says Kuntz. "He had a previous blowup at Deutsche Bank that the CEO of Amaranth told us they were quite aware of when they hired him. They said they ran the checks and he completely checked out," Kuntz says. "They prided themselves on their risk management."