Amaranth's Risky Business
It appears risk management went out the window at Amaranth, the giant hedge fund that lost $4 billion on a bad bet on natural gas prices.
The six-year-old hedge fund's big gamble that natural gas prices would keep rising paid off for much of the summer. At one point, the Connecticut-based fund was up 20% for the year -- boosting its assets under management at one point to a little over $9 billion.
But in a span of a week, all those paper gains, and more, went up in smoke. Last week's sudden fall in the price of natural gas meant that the hedge fund ended up losing nearly four times as much as it had gained.
Now, Amaranth is telling investors that it's 35% in the red for the year. The asset base has shrunk to about $5 billion. And that's before investors have had to chance to pull money out of the fund -- something that could happen in the coming months.But what made Amaranth's gamble so disastrous is that it borrowed heavily from its brokers to bet on the spread between natural gas contracts. By one estimate, for every dollar of its own money that Amaranth put down, it used $5 in so-called leverage. That ratio can produce a big payday if a trader makes the right bet. But when a bet goes awry, all that leverage only magnifies the losses.
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