Who are the winners and losers here? Hunter is a winner and will get relocated soon. He has hundreds of millions, having made about $75 million in 2005 (out of his team's $ 1.26 billion profit), and will likely make more later. Of course, his reputation is tarnished but $ 100+ million in fees over the years helps. Like many others, Hunter had to leave 30% of this in the fund so some of the $ 75 million was lost. There might be some lawsuits but he likely will not be hurt much. At 32, he is set for life financially, despite the losses.
1 An academic treatment of a rogue trader is in Ziemba and Ziemba (2007). Here we sketch some ideas.
He is likely to begin again. An executive recruiter has offered to help introduce Hunter to investors. He sees opportunities for Hunter to make a fresh start with high-net-worth investors, possibly in Russia and the Middle East.2 Betting on fallen hedge-fund stars is not all that uncommon. John Meriwether, who led Long-Term Capital Management until its 1998 implosion, now runs another hedge fund. Nicholas Maounis, Amaranth's founder and CEO, is exploring starting a new hedge fund. Instead of being ahead 27 % for 2005 his fund had to be liquidated. He lost much of his previous fees by leaving much of it in the fund. Since 2005 produced $ 70 million in management fees and $ 200 million in incentive fees, his cut was substantial but like LTCM, he should have diversified more.
Other winners are those on the other side of the trade if they followed proper risk control and could weather the storm created by Amaranth's plays and those like Citadel Investment Group, Merrill Lynch and J.P. Morgan Chase who took over Amaranth's portfolio and the Fortress Investment group, which helped liquidate assets. J.P. Morgan was named 'Energy Derivatives House of the Year, 2006' by Risk magazine.
The losers are mainly the investors in Amaranth including various pension funds which sought higher returns to make up for 2000-2003 equity investment mistakes. As of January
30, 2007, they have received about $ 1.6 billion which is less than 20 % of their investment value in August 2006. They will receive a bit more but their losses will exceed 75 %. Those who invested in mid 2005 have received about 27 % of their original investment or about 18 % of the peak August value. Other losers are hedge funds which were swept up by the Amaranth debacle including those that lost even though they bet on the right (short) direction because Hunter moved the market long on the way up like Mother Rock LP and those who lost along with Amaranth on the way down. They were long October and short September futures. According to Till (2006), they likely were forced out of their short position August 2, 2006 when the spread briefly but sharply rallied. Another loser was Man Alternative Investments Ltd., a fund of hedge funds listed on the London Stock Exchange in 2001 by the Man Group PLC, which shut down after recent losses tied to Amaranth's collapse and persistently poor liquidity in the shares. It is a small fund with little active trading interest, a concentrated shareholder base, and positions that were both difficult to build up and unwind. It had about $ 31.5 million invested in a portfolio selected by Man Group's Chicago-based Glenwood Capital Investments LLC unit, is part of Man Group PLC, which has $58 billion in assets under management. The fund lost about one-fifth of its gains this year from the collapse of Amaranth though it was up 6.5 % through October.
Archeus Capital, a hedge fund that in October 2005 had assets of $ 3 billion, on October
31, 2006, announced it would close returning $ 700 million to their investors. The fund, founded and run by two former Salomon Brothers bond traders, Gary K. Kilberg and Peter G. Hirsch, was like Amaranth, a multistrategy fund. However, it had a more conservative approach that focused on exploiting arbitrage opportunities in convertible bonds. Archeus began experiencing redemptions last year after its main investment strategy fell out of favor. The fund's founders blamed its administrator for failing to maintain accurate records. Their subsequent inability to properly reconcile the fund's records, led to a series of investor
2 Indeed in late March 2007, it was widely reported that Hunter was soliciting money for a series of commodity funds with the name Solengo Capital. It is believed that cash rich investors in the Middle East and Europe are likely to invest. To assuage fears of another meltdown, investors will be able to pick specific managers and commodities. The new fund will impose margin and other restrictions on managers and will eliminate all lock-in restrictions if these controls are violated. The prices of the natural gas contracts Mr Hunter is known to favor had been increasing in anticipation of his return to the market.
withdrawals from which they were not able to recover. Also, Archeus's 2006 performance did little to inspire its clients. Through the first week of October 2006, Archeus's main fund was down 1.9 % for the year. However, the fund had returned 18.5 % since July 2005. Still, during a period when hedge fund returns have come under increased scrutiny and have, on average, lagged the returns of the major stock market indexes, such a return was insufficient to keep investors on board.
The $7.7 billion San Diego County Employees' Retirement Association has retained the class-action firm Bernstein Litowitz Berger and Grossmann to investigate the Amaranth implosion. Its $ 175 million investment in Amaranth, which was valued at $234 million in June 2006, is now estimated to be worth only $ 70 million, thus a $ 100+ million loss. They should have done better due diligence in advance. Those who bet the ranch on every trade eventually lose it. Investors should have known that was what they were investing in with Amaranth.
Following Amaranth's collapse, while investors were seeking someone to blame, some argued that these bets showed the need for greater or a different sort of regulation of hedge funds, or at least their over the counter trades. Others including Gretchen Morgenson of the New York Times, pointed to the persistence of what many of have called the Enron Loophole, created in 1993, when the Commodity Futures Trading Commission (CFTC) exempted bilateral energy futures transactions from its regulatory authority. This exemption was extended in 2000 in the commodity futures modernization act to include electronic facilities. Many have argued that Enron used such trades to increase the value of long-term contracts. In the run-up of gas prices in 2005/2006, some analysts and politicians pointed to the role of speculators in changing the demand structure, leading a congressional subcommittee to release a report urging that such trades all be the concern of US regulators. Amaranth's collapse brings a different aspect to this debate, as it shows the limits to such self-regulation by market actors. While it is unclear what policy actions might be taken in this matter, this concern is likely to continue and may change the environment in which such trades are made in the future. However, there are limits to the role that can be played by such regulation.
Other small losers are funds of funds of Morgan Stanley and Goldman Sachs who lost 2.5 % to 5 % from their Amaranth holdings. However as they helped unwind the trades they may well have recouped their losses as the energy markets subsequently increased.
There is little impact from this on the world economy. The hedge fund industry now has a bit more pressure to regulate position sizes but most regulators steer away from risk control. When you mention risk control, you are usually encouraged to change the subject. What regulators are interested in is operational risk. The exchanges have limits but rogue traders are able to get around these rules. In any event, if VAR were to be used it would most likely not work unless one is blessed with no bad scenarios. As long as risk control is so poorly understood, misapplied and disregarded and pension funds and others are desperate for high returns, such disasters will occur from time to time; and this is fully expected. It is simply part of the hedge fund zero sum gain. For every Jim Simons or Blair Hull eaking out steady profits using a lot of careful research, excellent execution, position sizing and strict risk control; there is a rogue trader trying to make it by over-betting with very little research and a firm which improperly applies risk control. Improper regulation may well hurt more than help.
This chapter is dedicated to our late friend and colleague University of Chicago Professor Merton Miller; he would have enjoyed it and hopefully would agree with our analysis.
Towards Scenarios: Country Studies
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If mutual funds seem boring to you, there are other higher risk investment opportunities in the form of stocks. I seriously recommend studying the market carefully and completely before making the leap into stock trading but this can be quite the short-term quick profit rush that you are looking for if you am willing to risk your retirement investment for the sake of increasing your net worth. If you do choose to invest in the stock market please take the time to learn the proper procedures, the risks, and the process before diving in. If you have a financial planner and you definitely should then he or she may prove to be an exceptional resource when it comes to the practice of 'playing' the stock market.