Multi-Strategy Hedge Fund
$600 Million in Cash
Hired Brian Hunter, a natural gas trader 6 years later
Bet for bad weather
Bought options at unlikely prices and double-bet his positions
Change in Weather Forecasts caused Prices to move out of favour
Led to Amaranth Advisor's eventural downfall
Set up by Nicholas Maonis
Traditionally deals with convertible arbitrage
Principle Business included:
-Investment Advisory Services
-Management of multi-trading hedge funds
-Energy Trading
Grew from small private trading firm to large scale institution
Operates with 20-50 employees with salaries as high as $5 Million annually
Clients includes
-Pension Funds
-Endowments
-Institutions
-High Net Worth Individuals
Most widely used sources of energy
Volatile Commodities Market
-Heavily Traded
-High Volume
-Vulnerable to Market Conditions
Prices affected by Supply and Demand
Winter vs Summer
Prices less Elastic than Crude Oil
-Lesser Emphasis
-Not easily Transported nor Stored
Adopted a long winter short summer strategy from 2006-10
Amassed large positions in gas futures
Prices began to fall in September
- Storage glut
- meek hurricane season
- mild winter
Losses amounted to $3.7 Billion within weeks
Margin calls led to sale of energy portfolio
Consists of departments involved in
- roles of trading
- market-making
- sales
Amaranth Established as a multi-strategy fund.
Trading Strategy proclaimed a false sense of security;
"Amaranth’s investment professionals deploy capital in a broad spectrum of alternative investment and trading strategies in a highly disciplined, risk-controlled manner."
- 58% of assets tied up in gas trades
- Thus adopted strategies that were not in line with what the firm set out to be.
Brian Hunter as Star Trader
- Made $1 Billion after Hurrican Katrina
- Allowed to trade from Hometown, Calgary
- Similar to Barings case in 1995
- Played both the role of a trader and risk manager
- Middle Offce monitors, facilitates, provide research analysis and feedback to Front Office
- Call out fine-grained compilations of trading (e.g. Var, liquidity positions, leverage)
- Amaranth lacked properly segregated Middle Office
Inadequate Risk Models
- Risk models employed failed to measure downside risk accurately (Based on historical data)
- Policies in place did not provide adequate protection againset volatile natural gas futures market
Lack of Monitoring resulting in overexposure to Liquidity Risk
- Rule of thumb to maintain position within 1/10 - 1/3 of average daily trading volume
- Hunter held extremely large positions on many occasions
- Massive positions increased Amaranth's losses
Margin Trading and Over Leveraging
- Commodities traders generally maintains 10% of their position's value
- Leverage likely as high as 17.84 when prices moved against him with only $3B available for margin calls
- Borrowed more money to double down
- Disclosed leverage peaked at 8:1
- Margin calls results in large losses
- Materializes profits from the trader's trades
- Serves as independent internal verifer
Inadequate Regulatory Compliance
- No absolute position limit presecribed by NYMEX
- Violations are investigated on Case-by-case basis, thus negotiation is possible
- Amaranth simply increased position on ICE after NYME limit their positions.
- Resulted in Amarant holding more than 40% of the open interest in the Market.
- Pertinent mistake of having single "Star Trader"
- Develop guidelines or limits of certain risk capital to certain traders based on quantitative factors
- Allows diversification of trade decisions
- Amarath had little impact on world's economy
- Prompt to review regulations and brought attention to potential risks
- Loopholes can always be found
- Can be mitigated or avoided only if risk controls adequately understood, appreciated, applied in firm's processes and operations
Preceding Circumstances
SOP Case Study
Middle Offce
Front Office
Back Office
Reccomendations
Learning Points
Aftermath
Transparency
Set stricter limits and base them on quantitative factors
- One exchange cannot obtain info from another exchange
- Either exchanges or an authority should be able to monitor all positions
- BO prepared to share necessary info. and stop transactions when limits are breached
Both exchanges and firm should be responsible
<$100m Bonuses
Offered by recruiter to work in other regions
Recognizing Risk Management
Diversification of Traders
- Less emphasis and regard given to lower paid RMs
- Smaller say on operations
- More incentives and attention such as bonuses
- Better sense of owernship
Paid unrealistic Prices
- Calls for better regulations
- Sent clear message against manipulating commodities mkt
Fund on Funds
Pension Funds
Other Hedgefunds