Amaranth Blowup

Hedge fund blowups fascinate me. You may have heard about the latest: Amaranth Advisors and Brian Hunter. It’s the biggest blowup since Long Term Capital Management in 1998. The markets barely blinked this time. The difference is that LTCM traded in bonds, and with bonds, banks give you much greater leverage – ie they lend you more money on margin. LTCM had 5 billion in equity, borrowed up to $125 billion, and leveraged up via derivatives to $1.25 trillion. LTCM borrowed about 20x-25x their equity. Hunter borrowed about 5x his equity. Assuming Amaranth let him run 1/3 of their portfolio, or $3 billion, Hunter borrowed about $12 billion off that $3 billion equity, for a combined $15 billion bet. With 5x leverage, a 20% decline wipes you out. Leverage kills if you get it wrong.

12 thoughts on “Amaranth Blowup”

  1. “A person familiar with Amaranth says the fund lost about 60% of its value in a single week because of the bad natural gas bets.”

    That must have been an unpleasant week.

    On the other hand, can you really say Amaranth “blew up” when it has met all its margin calls? Doesn’t that mean it is continuing to operate?

  2. According to the book “When Genius Failed”, when you take into account all the private derivatives LTCM held with IB’s, they were leveraged almost 100-1.


    Just goes to prove a 180 IQ won’t protect you from basic human emotions.

  3. Unpleasant week indeed. “Blowup” is a subjective term. I use it whenever a fund goes through a disaster, so may not be tecnically correct in using it.

    It’s always interesting to see if the guy central to this will make it back. John Meriwether and Victor Niederhoffer both did. I’m betting that Brian Hunter will be back in a few years.

  4. “Just goes to prove a 180 IQ won’t protect you from basic human emotions.”

    The fascination part of it for me is their desire to make bigger bets. I think the normal progression is to become very successful, feel invincible, then take bigger bets. I wish they would just go enjoy their money or something, not get addicted to the high.

  5. Nomenclature aside, this will put them out of business, although they will probably be able to cover their debts. Investors who have lost over 1/2 their equity in a matter of months are not likely to stay, and the firm will have to sell off to pay out the equity. I don’t expect any sales effort to be able to overcome that performance record.

    There are a lot of restrictions on what a public fund can do (I’m including ’40 Act mutual funds, UITs, ETFs, etc.). Most private arrangements have restrictions built into the trust documents (common trust funds, charitable remainder trusts, pension plans, individual trust funds, etc.). The whole point of a hedge fund is giving the manager nearly complete discretion with nearly no oversight. Commodities, naked short positions, leverage, structured debt, private placements (not just 144A), real estate, currency, derivatives of any flavor – it’s all there. Pretty much anything that can be bought, sold, or promised is fair game. Hedge fund managers typically give only the slightest hint of what their investments may be at any given time, so the customer really has no alternatives to putting blind trust in the manager or staying out of the fund.

    I’ve seen very good money managers (and some not so good) walk (or get shoved) out the door and realize their dream of running their own shop. Hedge fund overhead is minimal; almost all the operating costs go to research, financial modeling, asset custody, and trading costs. It’s like starting Apple or Hewlett-Packard in your garage. You don’t need much start-up capital, just enough money under management to trade efficiently.

    It’s not even the bad managers who are causing the problems. Hedge fund managers are essentially arbitrageurs. The influx of competent managers means that opportunities to discover and exploit pricing anomalies are increasingly scarce, brief, and risky. And when a major unforeseen market event like the Russian debt or Asian currency crises happen, it can get very ugly. This fund was killed by a fairly routine market adjustment in natural gas. Just wait ’til something big happens and everybody needs to sell but nobody wants to buy.

  6. “Just goes to prove a 180 IQ won’t protect you from basic human emotions.”

    A lot of what I wrote about when I started blogging was why a 180 IQ will get you someone who is less likely to learn from his or her mistakes, rather than more likely. There is a series of humorous pieces on the foibles of Chemists from the 1970s, and the one I like best goes something like “the average Chemistry prof is a crafty old bugger who could rationalize the first 50 numbers in the phone book into a kinetic mechanism if presented in liters / (mol * sec)”. It’s this ability to rationalize their own stupidity, coupled with emotional retardation from being the odd kid out in childhood and concentrating so much on technical subjects when other people were out socializing in college and young adulthood, that makes technocrats dangerous.

  7. good point. It wasn’t a “mistake”, it just wasn’t modeled properly.

    Don’t leftists say the same thing about Socialism?
    “We’ll get it to work any day now!”

  8. My favorite asspect of Hedge Funds is that when they make money the managers get 20% of the profits and the investors get the rest. When the hedge fund looses money, the investors loose 100% of the money.

  9. Robert,

    True. OTOH, managers are often big investors in their own funds — a selling point — in which case a performance debacle not only costs them their jobs but perhaps also substantial parts of their net worths.

  10. Amaranth, in my opinion, has more to do with market correction, unfortunate in this case, than intellectual arrogance.
    LTCM, I believe has taught those “180 IQs” a lesson, they are not going to forget anytime soon.

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