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October 2, 2006
Hedge fund bets were too large
The bets in the natural gas market that lost $6bn for hedge fund Amaranth were "much too large for its capital base", according to a new study of the losses conducted by Edhec, the French business school.
The fund's risk managers could have identified how "massively risky" the fund's positions were, even based on historical market moves that would have underestimated the difficulty of exiting the trades, the study concludes.
Nick Maounis, founder of Amaranth, has said the fund's huge losses followed "highly remote" moves in the natural gas market.
The Edhec study, based on public reports of the debacle, confirms that the price changes were extremely unlikely based on historical analysis. But it also notes that the size of Amaranth's positions made unusually sharp market moves almost inevitable as it tried to scale them down.
Hilary Till, a research associate at Edhec and a principal of Premia Capital Management in Chicago, said her analysis suggested the market moves that hit Amaranth were statistically even more improbable than those that brought down Long Term Capital Management in 1998.
The probability of those events has been likened to the chance of a meteor hitting the earth. But with positions as large relative to the market as Amaranth's, the attempt to get out of trades can itself dramatically move prices.
For her report, to be released this week, Ms Till recreated Amaranth's likely positions based on information that has been made public by the media and the fund since its losses came to light two weeks ago.
Monthly gains or losses of more than 10 per cent were not unusual for Amaranth. This volatility should have told investors the fund's energy trading was "quite risky", Ms Till concluded.
Meanwhile, those informed about specific trades would have seen that the fund's positions in over-the-counter natural gas derivatives were "massive" compared with the publicly disclosed open interest in exchange-traded futures markets.
"[That] would have given an indication of how illiquid their energy strategies were," said Ms Till.
In spite of the losses, Ms Till said Amaranth had been performing a useful function in the energy markets. "Amaranth was providing liquidity to natural gas producers," she said. Such companies and gas storage groups would have been taking the other side of many of the hedge fund's trades, helping them to manage their business risks.
-The financial Times-
Posted by su at October 2, 2006 11:46 AM