Study On Amaranth Advisors American Investment Advisor Finance Essay
Founded in 2000 in Greenwich, Connecticut by Nicholas Maounis, Amaranth Advisors LLC was an American investment advisor. Before beginning Amaranth, Maounis have had experience in managing a range of international arbitrage accounts in United States, Japan, Europe, Canada, and other countries. Amaranth started as a hedge fund which was able to handle as much as $9 billion assets but essentially collapsed in September 2006 after losing more than $6 billion due to the unexpected price change on natural gas futures. The breakdown was marked as one of the largest known trading losses and hedge fund collapses in history.
It is known that convertible arbitrage was Amaranth’s primary profit center as proven throughout much of the firm’s history. As more and more capital streaming into the convertible arbitrage strategy in the early 2000s, it became more difficult to find trading opportunities. Amaranth Advisors had various kinds of investors investing in the firm including pension funds, endowments and large financial firms like banks, insurance companies, and brokerage firms.
Amaranth Advisors had shifted much of its capital to energy trading by 2004. At that time, Amaranth’s energy desk was run by the firm’s energy trader, a Canadian named Brian Hunter. Hunter placed spread trades in the natural gas market and in 2005, he successfully made huge profits by placing bets on natural gas price, the year where Hurricane Katrina had severely impacted natural gas and oil production. Hunter predicted that the price of natural gas will increase continuously and believing that the performance when he earned enormous profits in 2005 will repeat, Amaranth bet the farm that the price of the March 2007 and March 2008 futures contracts would rise relative to the price of April 2007 and April 2008 contracts. Hunter’s strategy here was to “long” the March contracts and “short” the April contracts.
The firm’s big gamble that natural gas prices would keep rising paid off for much of the summer until at one point, the firm’s fund was up 20 percent for the year. This, eventually, had boost Amaranth’s assets to a little over 9 billion dollars, as mentioned previously. However, in a span of a week, the sudden fall in the price of natural gas meant that the hedge fund ended up suffering a great loss. The spread between the March and April 2007 contracts went from $2.49 at the end of August 2006 to $0.58 by the end of September 2006. The decline in the spread was disastrous for Amaranth, resulting in $6.5 billion of loss.
Amaranth had over $6 billion under management and reports indicate losses may exceed 65 percent. It was reported on September 20, 2006, that Amaranth would transfer its energy portfolio to a third party, revealed as Citadel Investment Group and JPMorgan Chase. The losses was not as threatening to the financial system compared to the losses of Long-Term Capital Management, but it led to increase pressure on the United States Securities and Exchange Commission to regulate hedge funds. But what made Amaranth’s gamble so disastrous is that Amaranth borrowed heavily from its brokers to bet on the spread between natural gas contracts. Nicholas Maounis sent a letter to fund investors notifying them of the fund’s suspension on September 29, 2006 and on October 1, 2006, he hired the Fortress Investment Group to help liquidate its assets.
The Amaranth Hedge Fund history is a good example of inefficient and incompetent work with investments. A hedge fund can be considered the best in case it can provide a firm growth of the policy taken and a stable development of the corresponding capital. It’s essential to be able to face with financial crisis and unexpected market fluctuations, but it’s not really important on how much can be earned from hedge done. The profit is defined not only by what has been earned, but also the losses one able to manage and escape.
2.0 THE AFTERMATH
As known, Amaranth was one of the largest hedge fund that expands and earns profit tremendously. Thus, the breakdowns of the company become an interest amongst the speculators, economists, hedge traders, businessmen, financiers and others. They were wondering about the causes and the consequences that arise from this misfortune. One stated that, the risk that come up from the hedge fund will only affect the investors that engage in the fund but not the bank dealer. Yet, they are overlooking that mammoth fund company like Amaranth will affect the financial system and initiate such an unpleasant monetary problem.
In Amaranth, due to margin calls and liquidity issues in September 2006, Nicholas Maounis have no other option except selling off their energy holdings. The energy portfolio of Amaranth was being sold to Citadel Investment Group and JP Morgan Chase. By that time, Brian Hunter, Amaranth’s head energy trader, had already left the hedge company. Commodity Futures Trading Commission (CFTC) and Federal Energy Regulatory Commission (FERC) were both having different charge on Brian Hunter. As for the CFTC, charged on Amaranth and Brian Hunter was made because of the attempt to manipulate the Natural Gas Futures price as well as providing the New York Mercantile Exchange with false statement while FERC charge Amaranth because of the market manipulation.
In January 2010, FERC reveal that Hunter violated the Commissions Anti – Manipulation Rule and this was the first ever case of market manipulation that had happened. A border was created for CFTC to monitor the activity of Amaranth since it shifted its positions to the Intercontinental Exchange (ICE) Natural Gas Swaps markets with no speculative limits. This happens once the fund reached speculative trading limits on the regulated New York Mercantile Exchange (Nymex) Natural Gas markets. The fall down of the Amaranth provided an advantage to another company, Centaurus, to be recognized as the major player on the other side of their position. Ultimately, the fall down of the Amaranth make all the investors and the hedge traders become more responsive in making their trading fluently and ensuring the profit of the fund managed.
3.0 LESSONS TO BE LEARNED
As stated before, September 2006 is the year where Amaranth advisor, the Connecticut hedge fund, lost $6 billion or we can say almost two thirds of its value. This due to the wrong expected at what cost the natural gas will be at the next spring.
From this tragedy, there were lessons to be learned from this wrong expected cost of natural gas. From the strategy that Amaranth had chosen, it seems as he was borrowing $8 for every $1 he invested. This strategy could be extremely dangerous if the cost be as what he expected but the moment the price differs with what he has expected, the loss will be extremely large. It could be double and redouble faster than any hedge fund manager expected.
Moreover, the price of the natural gas futures could be very volatile. So investor should be very sensitive of the very volatility cost. Most of the investor did not take enough notice about this fact and they simply wager at higher cost of each bet. So, in order to prevent this tragedy from happened, investor should be very alert although this is only small problem that noted in this event.
In addition, two significant elements were expected due to the collapse. Firstly, most of the investor did not even know what will happen in the cost of the natural gas and how risky the event could be. Because of the riskiness of this event, it will be reasonable to expect investors in a hedge fund to leave the details of where to invest to individual manager, it is also reasonable to make sure that they have information of the risks that involved in this multi strategy.
Second largest collapse of a hedge fund ever recorded made the industry as a whole barely batted an eyelid over this collapsed. In order to prevent this collapse happened again, financial world should not become used to such individual blips. Besides, financial world should concern about the riskiness of the event if the cost of the financial that they want to hedge turn to other side.
As conclusion, the lesson that the investors should remarks over this collapse is the investor should avoid the dangers by putting all the eggs in one basket. They should not bet all their money only in one strategy. They should take lessons from this collapse by avoiding putting higher amount of money in only one strategy.
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