EDHEC-Risk Concept Industry Analysis Featured Analysis Latest EDHEC-Risk Surveys Features Interviews Indexes and Benchmarking FTSE EDHEC-Risk Efficient Index Series FTSE EDHEC-Risk ERAFP SRI Index EDHEC-Risk Alternative Indexes EDHEC-Risk IEIF Commercial Property Indices Hedge Fund Index Research Equity Index Research Amundi ETF "Core-Satellite and ETF Investment" Research Chair EDHEC-Risk Institute Solvency II Benchmarks Index Regulation and Transparency ERI Scientific Beta Performance and Risk Reporting Hedge Fund Performance EuroPerformance/EDHEC-Risk Institute Style Ratings Performance Measurement for Traditional Investment CACEIS "New Frontiers in Risk Assessment and Performance Reporting" Research Chair Asset Allocation and Alternative Diversification Real Assets Meridiam Infrastructure/Campbell Lutyens "Infrastructure Equity Investment Management and Benchmarking" Research Chair Natixis "Investment and Governance Characteristics of Infrastructure Debt Instruments" Research Chair Newedge "Advanced Modelling for Alternative Investments" Research Chair CME Group "Exploring the Commodity Futures Risk Premium: Implications for Asset Allocation and Regulation" Strategic Research Project Asset Allocation and Derivative Instruments Volatility Research Eurex "The Benefits of Volatility Derivatives in Equity Portfolio Management" Strategic Research Project SGCIB "Structured Investment Strategies" Research ALM and Asset Allocation Solutions ALM and Private Wealth Management AXA Investment Managers "Regulation and Institutional Investment" Research Chair BNP Paribas Investment Partners "ALM and Institutional Investment Management" Research Chair Deutsche Bank "Asset-Liability Management Techniques for Sovereign Wealth Fund Management" Research Chair Lyxor "Risk Allocation Solutions" Research Chair Merrill Lynch Wealth Management "Risk Allocation Framework for Goal-Driven Investing Strategies" Research Chair Ontario Teachers' Pension Plan "Advanced Investment Solutions for Liability Hedging for Inflation Risk" Research Chair Rothschild & Cie "The Case for Inflation-Linked Corporate Bonds: Issuers' and Investors' Perspectives" Research Chair Russell Investments "Solvency II" Research Chair Non-Financial Risks, Regulation and Innovations Risk and Regulation in the European Fund Management Industry Index Regulation and Transparency Best Execution: MiFID and TCA Mitigating Hedge Funds Operational Risks FBF "Innovations and Regulations in Investment Banking" Research Chair EDHEC-Risk Publications All EDHEC-Risk Publications EDHEC-Risk Position Papers IPE EDHEC-Risk Institute Research Insights AsianInvestor EDHEC-Risk Institute Research Insights P&I EDHEC-Risk Institute Research for Institutional Money Management Books EDHEC-Risk Newsletter Events Events organised by EDHEC-Risk Institute EDHEC-Risk Days Europe 2015, London, 24-25 March, 2015 Events involving EDHEC-Risk Institute's participation EDHEC-Risk Institute Presentation Research Programmes Research Chairs and Strategic Research Projects Partnership International Advisory Board Team EDHEC-Risk News EDHEC-Risk Newsletter EDHEC-Risk Press Releases EDHEC-Risk in the Press Careers EDHEC Risk Institute-Asia EDHEC Business School EDHEC-Risk Executive Education EDHEC-Risk Institute PhD in Finance Yale School of Management - EDHEC-Risk Institute Certificate in Risk and Investment Management Yale SOM-EDHEC-Risk Alternative Investments I Seminar, New Haven, 2-3 December, 2014 Investment Management Seminars CFA Institute/EDHEC-Risk Advances in Asset Allocation Seminar, London, 3-5 February, 2015 Masterclass on Individual Investor Solutions, London, 23 March, 2015 CFA Institute/EDHEC-Risk Advances in Asset Allocation Seminar, New York, 7-9 July, 2015 Contact EDHEC-Risk Executive Education Contact Us ERI Scientific Beta
Features
Alternative Investments - October 02, 2006

EDHEC comments on the lessons to be drawn from the Amaranth debacle

In a little over a week, Amaranth Advisors, a respected, diversified multi-strategy hedge fund, lost 65% of its $9.2 billion assets. In a paper entitled ‘EDHEC Comments on the Amaranth Case: Early Lessons from the Debacle’, noted commodities expert Hilary Till, Research Associate with the EDHEC Risk and Asset Management Research Centre and Principal of Premia Capital Management, LLC, examines how Amaranth could have suffered such massive losses and draws lessons from this debacle for investors, funds of fund & energy fund risk managers, multi-strategy hedge fund managers, policy makers, and the alternative investment industry as a whole.

Ms Till finds that the fund employed a Natural Gas spread strategy that would have benefited under a number of different weather-shock scenarios. These were economically defensible, although the scale of their position-sizing relative to the capital base clearly was not. Using a returns-based analysis to infer the sizing of positions, it is found that the Amaranth’s energy portfolio likely suffered an adverse 9-standard-deviation event on the Friday (September 15th) before the fund’s distress became widely known. Ms Till draws six early lessons from the debacle:

  1. Investors would not have needed position-level transparency to realize that Amaranth’s energy trading was quite risky. A monthly sector-level analysis of their profits and losses (p/l) would have revealed that a –24% monthly loss would not have been unusual;

  2. If investors did have position-level transparency, they would have likely noted that the fund’s over-the-counter Natural Gas positions were massive compared to the prevailing open interest in the exchanged-traded futures market, which would have given an indication of how illiquid their energy strategies were;

  3. Risk metrics using recent historical data would have vastly underestimated the magnitude of moves during an extreme liquidation-pressure event;

  4. If the fund’s risk managers had employed scenario analyses that evaluated the range of Natural Gas spread relationships that have occurred in the not-too-distant past, they would have caught how massively risky the fund’s structural position-taking was in its magnitude;

  5. It is essential for a commodity trader to understand how their positions fit into the wider scheme of behaviors in the physical commodity markets: before initiating any large-scale trades in the commodity markets, a trader needs to understand what flow or catalyst will allow a trader out of a position; and

  6. Amaranth was likely indeed providing an economic service for physical Natural Gas participants; this hedge fund provided liquidity for physical-market participants who could then lock in the value of forward production or the future value of storage. But even so, like Long Term Capital Management, the scale of Amaranth’s spreading activities was much too large for its capital base.