When price deviation never corrects
Firms Involved
- Amaranth Advisors
Year of the event
2006
Description of the case
Amaranth Advisors was a multi-strategy hedge fund founded in 2000 by Nick Maounis. In 2006, 75% of its returns were generated by the Energy division headed by Brian Hunter. He was heavily betting on natural gas futures. At the end of August, the fund had had a great year, piling several double-digit Month-on-month returns and totaling over $9bn of assets. However, 18 days laters, Nick Maounis was sending a letter to the investors, explaining that the fund had seen its assets shrink by 50% due to losses on natural gas futures trading. The fund was overtaken by Citadel and JP Morgan Chase, and consequently liquidated by Fortress Investment Group. Hunter had implemented a "calendar spread strategy" engaging half of the fund's assets, whereby he was long on winter months and short on non-winter months [1]. He believed indeed that the supply did not precisely match the seasonality of the demand for natural gas. As the losses in September 2006 attest, his view did not materialize in a timely manner, and the heavy leverage he used coupled with the low liquidity of the market got the better of the fund[2].
Take-aways
- "The markets can remain irrational longer than you can remain insolvent" (apocryphal, attributed to John M. Keynes).
- Risk Management must be taken seriously. In particular, risk attribution between the various trading streams must be carefully implemented and monitored.
