Hedge Fund Amaranth Advisors Lost $6 Billion

Betting the House and Losing Big: NYT

Amaranth’s funds, among the hottest hedge funds of recent years, have lost $6 billion, or nearly two-thirds of their value, in recent weeks as once-profitable bets on natural-gas prices suddenly turned bad. Amaranth made $800 million for investors in energy trading in 2005 and got around 250 million in performance fees.

The Fund applies a "multi-strategy" for its funds, which really means that the fund managers are free to do whatever they like to do, including utilizing one single strategy and putting all money in one bet with margins:

The debacle confirms what many in the hedge fund business know but perhaps too often ignore: Betting the house can result in enviable returns; it can also take down the house. ... The fund’s mettle was tested in the bear market of 2002. When the major indexes fell 17 percent or more that year, Amaranth Partners, one of its flagship funds, produced returns of 11.33 percent. During the next two years, Amaranth delivered consistently solid, if not spectacular, returns.

Amaranth’s problem would become one all too familiar to financial firms: liquidity. Mr. Hunter[the firm's genius trader - R.W.], bet that the spread between natural gas futures for March 2007 and April 2007 would rise. In fact, it collapsed. Mr. Hunter could not sell his positions. Others in the market saw that his bullish bet was wrong, that he was losing money and they continued to bet against the market, pushing prices lower. ... Once the trade went sour, Amaranth was trapped: selling into a falling market, scrambling to meet margin calls from nervous lenders, stuck in a position in a market where — to use a common phrase on Wall Street — “you get your face ripped off.”

The excuse by the fund management also sounds familiar:

“Sometimes, even the highly improbable happens, ... That is what happened in September.”

Isn't that the same excuse by those genius traders at the now-infamous Long Term Capital Management (LTCM)? Statisticians have repeatedly demonstrated that the extreme events - the "long tail" - do occur much more often than one normally expects.

For the rest of the story, see the New York Times article: Betting the House and Losing Big.