With all the stories attempting to deconstruct the Amaranth Advisors LLC hedge fund blow up, it is hard to know exactly what truly happened; besides, of course, that it lost approximately 65% or $6 billion in a week’s time. One thing is for sure, stories attributing the losses to a bad long bet on natural gas are overly simplistic. While that may have been the net affect, institutional allocators, the likes that were invested in Amaranth, would never allow their money to be placed in a fund with that much naked exposure.
No, Amaranth’s positions were hedged, or thought to be hedged.
When the energy-based hedge fund Mother Rock LP, run by former New York Mercantile Exchange president J. Robert “Bo” Collins, announced in early August it would be winding down operations due to massive losses, a source close to the fund informed Futures that strange behavior in volatility and calendar spreads were behind the massive drawdown. It is clear that several basis relationships within the natural gas complex began getting out of whack from the beginning of 2006. While these anomalies provide added opportunities and added risk, they also change everything.
Our source pointed out fundamental relationships within the complex that existed for 10 years — through punishing bear and bull markets alike — had changed. That would suggest the risk metrics used to stress test such positions may have been obsolete and inadequate at measuring risk.
That is significant as several sources have reported that Amaranth had picked up some of the Mother Rock positions after it had wound down.
Hilary Till, principal of Premia Capital Management and research associate for the EDHEC Risk and Asset Management Research Centre, attempted to reverse engineer Amaranth’s positions in a report for EDHEC. Based on public information, she suggests Amaranth held short-summer/long-winter natural gas spreads going out several years. She concluded, as have others, that Amaranth was positioned to benefit under a number of different weather shock scenarios. She added that while the strategies were defensible, “the scale of their position sizing relative to their capital base clearly was not.”
Others have simply called it a hurricane play. Those analysts surmising that Amaranth was making a calculated bet on another bad hurricane season could also be accused of oversimplification but given what we know this was probably at least part of the strategy. And seeing that the contango from summer to winter gas had quadrupled throughout the first six months of the year, it is fair to say that a bad hurricane season was already priced into the market and the only place for the spread to go was back towards historical relationships.
