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On eve of loss, Amaranth touted plans for new energy fund

The head of Amaranth Advisors LLC was so proud of its natural gas trading strategy that he told investors a few weeks ago the hedge fund had directed 56 per cent of its capital into energy investments and planned to start a new energy fund.

Nick Maounis, Amaranth's founder and chief executive officer, told investors in a letter last month obtained by The Globe and Mail that while the fund planned to target a smaller allocation to natural gas investments in the future, "we believe opportunities in the natural gas market remain attractive and continue to maintain positions where we believe fundamentals are disconnected with current prices."

The letter was sent some time in August, not long before the fund's main natural gas trader, Brian Hunter, started running into trouble when the price of natural gas turned dramatically against him. Industry observers say Mr. Hunter had made a series of bets based on the conviction that the price of natural gas would climb. Instead, the price dropped amid weather forecasts predicting a milder winter and a tamer than expected hurricane season.

On Monday, Mr. Maounis warned investors that the firm's "multistrategy funds sustained significant losses in their energy-related investments" last week "following a dramatic move in natural gas prices." The result was a loss of roughly $4.5-billion (U.S.), cutting Amaranth's assets in half.

Yesterday, Amaranth said it had transferred its energy portfolio to a third party. There were reports that Citadel Investment Group LLC and JPMorgan Chase & Co. have taken over some of Amaranth's energy trades. Meanwhile, the Attorney-General for Connecticut, where the company and many other hedge funds are based, is looking into what happened with the fund.

Amaranth's investors may have a tough time getting out of the fund, though the company recently changed its rules on redemptions to make it a bit easier, according to the August letter. Prior to Sept. 1, investors had to lock in for 25 months. As of Sept. 1, they can withdraw 15 per cent of their money every quarter.

While many of Canada's large pension funds have substantial investments in hedge funds, few acknowledged any dealings with Amaranth yesterday. Officials at the Ontario Teachers Pension Plan and the Ontario Municipal Employees Retirement Board, two of the largest pension funds in the country, declined to comment on whether they had any holdings with the hedge fund. The Caisse de dépôt et placement du Québec, which has more than $100-billion (Canadian) in assets, had $77.3-million invested in an Amaranth fund as of Dec. 31, 2005. A spokesman for the pension fund declined to say whether it still held the investment.

One Canadian hedge fund, Toronto-based Abria Financial Group, had about $18-million invested with Amaranth from 2002 on. Henry Kneis, Abria's CEO, sent out a message last night to his clients telling them about Amaranth. He said he's disappointed in what happened but there was no way Abria could have seen this coming. "We're just trying to get our capital out and move on."

This week's announcement from Amaranth was a far cry from the bullish comments in Mr. Maounis's August update. In that letter, he noted that while the company's funds had lost less than 1 per cent in July, they were up nearly 20 per cent for the year to date.

Mr. Maounis acknowledged in the letter that Amaranth's commodities portfolio experienced losses in July, mainly because of a "tightening of spreads in natural gas." That is a reference to the difference in prices between various natural gas contracts, typically monthly contracts dated well into the future. Calgary-based Mr. Hunter had made a fortune betting that the spreads would widen because gas prices would continue to climb. But as prices collapsed, the spread narrowed putting him offside on his trades.

Amaranth had a lot riding on Mr. Hunter. According to the August letter, the firm had allocated 56 per cent of its capital to energy investment strategies. That compared with 7 per cent for "long/short equity," 17 per cent for "credit products" and 6 per cent for commodities. Even the collapse of another hedge fund, MotherRock LP, which went out of business in early August because of a bad call on natural gas, did not seem to faze Mr. Maounis, according to the letter. "Given these circumstances, our natural gas book behaved quite well as we have taken steps since May to reposition our holdings," he wrote.

Several hedge fund watchers said they were surprised that Amaranth, which had been noted for its risk-averse investment strategy, had allowed Mr. Hunter to apparently take such a speculative position. Others say Amaranth is certain to draw more scrutiny to hedge funds from regulators and investors.

"I don't think the investors are happy -- no one's happy losing half their fund," said Les Marton, managing director at Scotia Capital, who runs the Canadian hedge fund performance index. "But it is buyer beware and investors can't just make blind kinds of bets in these kinds of funds. The fact alone that this was a very large, well-staffed operation doesn't necessarily mean that there aren't risks involved."

Franc Godri, Canada's managing director of Lake Shore Asset Management, added that the Amaranth problems may do the industry some good. "It's always good long term. It forces everybody to get back to basics," he said. "When greed and arrogance run rampant, these events are the great equalizers and they bring things back into perspective."

© 2007 The Globe and Mail. All rights reserved.

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