Pensions, Funds of Hedge Funds Hit Hard By Amaranth Woes

Sep 22 2006 | 6:07pm ET

The carnage reaped by the devastating losses in natural gas trading suffered by Amaranth Advisors hit some pension funds particularly hard, and that may serve as a powerful inducement as regulators and legislators debate the future of hedge fund regulations.

3M’s pension fund had about $92 million with the Greenwich, Conn., hedge fund. The San Diego County Employees Retirement System placed $175 million last year. Canada’s largest public pension fund, the Caisse de dépôt et placement du Québec, invested US$68.5 million.

Funds of hedge funds, a popular investment among public pension funds, are also taking it on the chin. As of June 30, Morgan Stanley’s Institutional Fund of Hedge Fund had $126 million with Amaranth, or 5.5% of the fund’s assets, according to Securities and Exchange Commission filings. At the end of the second quarter the Goldman Sachs Dynamic Opportunities Fund, a London-listed offering, had 5% of its assets with Amaranth, and the losses could saddle it with as much as a 3% decline this month. A U.S.-based Goldman FoHF, Goldman Sachs Hedge Fund Partners, also had $13 million with the firm, according to filings.

“I don’t think that pension funds should be invested in hedge funds. Why would you invest someone’s pension fund in a fund that is 40-times levered?” asked Mark Smith, founder and managing partner of risk management firm Mark Edward Advisors. He added that while many equity hedge funds are leveraged two or three times, futures funds and other strategies are often leveraged at a much higher rate.

The fiasco at Amaranth is being called the biggest hedge fund
collapse since Long Term Capital Management eight years ago. The firm’s head trader, Brian Hunter, lost up to $4.5 billion of the firm’s $9.5 billion in assets this month in natural gas trades gone bad.

“My understanding is that they let him build upon positions and double down, there is a level of fiduciary respond that has been dropped and a little bit of greed that was added,” Smith said. “The risk manager has to be isolated from everyone else and they have to be empowered,” he said.

Meanwhile, some see opportunity in the firm’s woes. Citigroup is reportedly in talk about buying a stake in the reeling hedge fund. The Wall Street Journal notes that on Hedgebay, a hedge fund secondary market, Amaranth investors are seeking 30 to 40 cents on the dollar, while prospective buyers are offering just 10 to 20. And Citadel Investment Group and JPMorgan Chase are poised to scoop up the firm’s disastrous energy trades, at very favorable prices, no doubt.

Then again, they may want to rethink that move: Amaranth bought a portfolio of gas trades this month once owned by MotherRock, the energy hedge fund that closed last month as a result of its natural gas positions.

Amaranth may not be the only prominent fund burned in the natural gas market—both Trafelet & Co. and Third Point have been mentioned. But given the failure of its risk-management system, which the Journal called “world-class,” and the pension funds crying foul, the repercussions could be enormous.

“This is a perfect example of gross mismanagement of risk. This one is the cherry on the top,” said Smith. “It shows that no matter what technology you have in place, you still need people, processes and procedures that make it work.”

Nor is the damage limited to the hedge fund world. Companies in which Amaranth held a big stake are tanking as the fund sells to meet margin calls. And Bermudan reinsurer Max Re Capital issued a press release saying its third quarter earnings would be hit “by an estimated $35 million reduction in net gains stemming from trading losses in certain hedge fund investments.”

Max Re Treasurer James Tees declined to name which hedge fund he was referring to in the release, but a source familiar with the matter confirmed that it was Amaranth.

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