Amaranth and Brian Hunter?

Brian Hunter was paid well for simply riding energy beta last year. Unfortunately for Amaranth that LUCK ran out with $6 billion lost through unskilled speculation on natural gas. "Multistrategy" turned out to be a single bet on a very volatile spread. There NEVER was any skill even in the good times. Highly concentrated gambling was not what Amaranth's marketing materials said.

What kind of investment process is "Many hurricanes last year so lots this year. Let's bet the fund"? Or "I am so clever I reckon the next five winters will be very cold"? What happened to the basic rules of investing? Diversification, hedging, risk management, position sizing. Even the rookie traders know not to have more than 2% of NAV at risk in any one trade no matter what their level of intelligence, conviction or brashness. Hunter's earlier profits were just random luck.

Who was conducting due diligence on Amaranth? The FIRST question I'd ask any fund of hedge funds">hedge funds is "Were you in Amaranth?". This incompetent bet was detectable ahead of time yet how many investors questioned it? Was anyone else reading the monthly reports and asking where the money was being made? There was plenty of time to redeem from a fund that plainly was not remotely diversified. Maybe some thought natty Mar/Apr was market neutral! Or an "arbitrage"?

The Amaranth plant was used in Aztec human sacrifices. Why did clients willingly step up to the altar to get their hearts ripped out? This exposure was knowable BEFOREHAND with a thorough examination of performance attribution statistics. If investors are bullish on natural gas they can easily buy NG futures themselves; no need to pay Brian Hunter $100 million lose money for them. Spreads in commodities can infamously be as volatile as the outright position, as any competent futures trader knows. Alpha - the transfer of capital from the unskilled to the skilled.

In a recent interview Steven Cohen, founder of SAC Capital, said he was worried by crowded trades. Of course he is. That's his job, as it is of every hedge fund manager. Nobody wants to be in trades that everyone else has on. No-one should be in positions they won't be able to exit in an orderly fashion. Risk must be evaluated, hedged and diversified away as much as possible. You can run $100 billion with a very wide spread of bets but not $9 billion wagered on a single horse. Some say Steven Cohen dodged a bullet not hiring Brian Hunter; nonsense, he would never have permitted such a clueless concentrated bet dominating the total portfolio.

Whilst providing ammunition for hedge fund critics, the Amaranth debacle has little to do with proper hedge funds">hedge funds and will have NO affect on industry growth. Predictions of a hedge fund bubble have been around for decades. Asset classes can form speculative bubbles but the hedge fund industry, managing strategies NOT assets, cannot. Many bona fide hedge funds">hedge funds have made good profits out of Amaranth's bizarre bet.

Highly diversified REAL hedged funds should be immune to market shocks. The tools and techniques of modern, sophisticated risk management ensure this. Short selling, appropriate use of derivatives and diverse holding periods eliminates the possibility of a hedge fund bubble. The conditions that might hurt, say, equity long biased funds will benefit short sellers, CTAs and global macro, for example. The variety of strategies available to invest in reduces exposure to implosions in any one asset class or security. Provided a real multistrategy fund is diversified across low cointegrated trades, downside risk is minimal. Especially considering the MINIMUM number of hedge funds">hedge funds ANY investor needs in their portfolio is at least 20.

One great strategy is to identify and take the other side of popular trades. This is not easy as such positions tend to get more crowded first, making good timing mandatory. Short squeezes and the lesser known long squeeze which killed Amaranth can be very lucrative. The zero-sum game dictates that the most money will be made when most other traders will lose it but such situations take skill and experience to regularly implement.

While there will be hiccups along the way in particular strategies, the hedge fund business is not in a bubble and WILL continue to grow longer term. But investors need to invest in true hedge funds">hedge funds NOT unskilled speculators whose luck runs out.

by Veryan Allen. Copyright

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