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Thursday, September 21, 2006

Management, Brian Hunter & Investors To Blame For Amaranth Advisors

By Yaser Anwar, CSC of Equity Investment Ideas

ADV in natural gas is approximately 11K contracts, with close to $50K per contract = $550 Million of daily turnover. OI is roughly 79K contracts with total value of just $4 Billion. What do you get? Extreme volatility.

For AA to loose 50% of its assets in a week goes to show that even after debacles such as LTCM & Barings, there was no precedence given to risk management. This catastrophe goes to show how hungry hedge funds have become with regards to generating alpha. Instead of monitoring the VAR closely, AA let "cowboy tactics" of one single trader, Brian Hunter, generate alpha for them. Who's at fault here? Management, Brian Hunter & Investors.

Management- Because investors trusted them with their assets, to exercise the necessary due diligence & keep a tight leash on their traders. As history has taught us, failing to do so, will only result in calamities no matter how good your "models" or "skills" are. Example: When Geniuses Failed at LTCM & Brash Gambling at Barings. Management should have paid more attention to Brian's antics at DB, which should have been a red flag. But of course not, Hedge Funds are too busy trying to generate Alpha. Can you blame them? With so many HFs popping up & as we discussed in Mr. Ehrenberg’s “Say It Ain’t So, Stevie?” post; the fragmentation of markets & disappearing opportunities, HF managements believe they are forced to swing for the fences. So when you swing for the fences once too often, you’re going to STRIKE OUT.

Brian Hunter- After being tagged as one of the best natural gas trader, Brian thought he was the market. Just like the LTCM group did. He forgot that the market has the ability to humble the best of them [flashback: LTCM]. Brian Hunter was also offered 10 million up front for jumping to SAC & up to 20%+ in profits from his trades. I can only imagine what that did to his ego.

Lastly, Investors- Why investors? I'll quote Barry Ritholtz who said it best, "Their investors demanded huge returns, and they turned a blind eye to the inordinate amount of risk required." We all know that Huge Returns HIGHLY CORRELATES with Huge Risk. They got what was coming to them, a disaster.

I doubt a coup like this would have been possible at the big brokers such as GS, JPM or BAC. Having read Goldman Sachs Culture of Success, I know they strongly discourage & straight up don't like any cowboy tactics, as were on display at AA, LTCM & Barings.

If you play with natural gas (fire), you are going to get burned, especially if you have leveraged yourself to a point of no return.

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