Will Amaranth Debacle Curb Enthusiasm for Hedge Funds of Funds?
News of colossal losses at one of the largest hedge funds in the U.S., Amaranth Advisors, throws yet another cloud over the alternative investments. At the very least, the sudden loss of $3 billion—due to wrong bets on natural gas prices—serves as a reminder of the outsized risks that clients face. And, coming after years of middling returns for the funds of funds that retail advisors sell, it raises the question of whether these pricey vehicles are worth it.
Amaranth, a so-called multistrategy hedge fund known for smart bets and strong performance, disclosed on Monday that its double-digit returns for the year had turned into a 35 percent year-to-date loss. Amaranth had $9.25 billion in assets before the spectacular downturn. Among the investors sharing those losses are funds of funds managed by Morgan Stanley, the Man Group, Credit Suisse, Deutsche Bank and Bank of New York, according to recent SEC filings.
The hedge fund industry has grown at a dizzying rate. Today, there are some 9,000 hedge funds managing $1.23 trillion in assets, up from 610 hedge funds and $38.9 billion in 1990, according to Hedge Fund Research. Fund of funds manage $426 billion. But even as the investment vehicles have become a major force in the market, they remain unregulated. In 2004, the SEC proposed a rule that would have required certain hedge funds to register with federal regulators and face stricter oversight, but that rule was struck down by a court of appeals in June, and the SEC has decided not to appeal the ruling. In the meantime, the SEC has said it plans to increase its vigilance of hedge funds through their dealings with broker/dealers.
Some hedge fund analysts were astonished by Amaranth’s losses. “Where was the risk-management team and risk-management systems?” asks one hedge fund analyst who requested anonymity. “A hedge fund with over 300 employees, of that scale, is typically expected to have extraordinarily robust risk supervision—both from a technological and personnel standpoint. What’s really shocking is that a fund that had achieved that level of prominence would stake so much of their business on one type of trade—or various trades that relied on one very volatile type of commodity. Can it really be possible that the firm didn’t know they were that exposed to natural gas?”
On the other hand, he says, the debacle could be help make a case for fund of hedge funds, which invest in a variety of different funds, thus spreading around the risk. “That’s the beauty of the funds of funds. These events happen once in a blue moon. What affect will this have on [fund of funds’] performance? Maybe they’ll be down a few percent for a month. Whereas investors who put money into Amaranth directly—they’re crushed. Rather than show that funds of funds are defective, it shows that there is a value to being diversified.”
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