Amaranth, Hedge Fund Risk Management and Pensions

Yes, amaranth is a grain but it's the CT based hedge fund by the same name that is making headlines. If you haven't read by now, Amaranth Advisors L.L.C. has reportedly lost $4 billion by taking long natural gas trades in anticipation of rising prices. (See "Amaranth's Risky Business" by Matthew Goldstein, TheStreet.com, September 18, 2006.)

Notwithstanding some obvious questions about oversight, the issue of risk management is unavoidable.

What was the organization doing to identify, measure and manage risk?

With about an hour of web sleuthing, I found a handful of job postings for Amaranth, all focused on analysis, modeling, risk and valuation. For example, an August 6 post describes the need for a technology analytics developer whose responsibilities would include the "development of real time systems supporting valuation and risk analytics".

Top name schools list (or listed) Amaranth as a recruiter of risk and computational graduates. More than a few Amaranth alums list their experience there as involving hedging, model building and/or risk analysis.

Amaranth is listed as a client by a UK risk management technology company.

In May 2006, the Chief Financial Officer was part of a panel entitled "Leading multi-strategy & single strategy funds explain the controls they use to maintain independence of the pricing function and the role of their administrators in fund valuation for different categories of illiquids and thinly traded securities".

On the face of things, it seems there was some focus on risk. Perhaps a lot. It's impossible to say from the outside looking in. It will be enlightening to all of us as we learn more about the firm's internal controls and risk trading systems.

Then, there are the investors.

What responsibility do they have to ask questions about a particular fund manager's risk management policies and procedures? New York Times reporter Mary Walsh writes that the County of San Diego had $160 million invested with Amaranth. No doubt we'll learn about other institutional investors as time goes by. (See "Pension Fund Tallies Losses and Rethinks Its Strategy" by Mary Williams Walsh, New York Times, September 20, 2006.)

What discussions took place between pension fund investors and Amaranth and/or the referring consulting firms? Was there a thorough drill down before writing a check? Can interested members of the public obtain the due diligence meeting notes?

What was the role of regulators?

In its September 15, 2004 letter rejecting the notion of SEC registration, the General Counsel for Amaranth at the time wrote that "Amaranth does not 'operate in the shadows' outside of regulatory scrutiny. Amaranth is registered as a commodity pool operator with the Commodity Futures Trading Commission, is a member of the National Futures Association and counts among its affiliates two SEC-registered broker-dealers who are members of the National Association of Securities Dealers and one investment counsel and portfolio manager registered with the Ontario Securities Commission. As a result, Amaranth already devotes significant resources to regulatory compliance and is subject to many compliance obligations that are duplicative of those that would be required by the Proposed Rule."

Could any or all of the regulators have identified problem areas before now?

Only insiders know what transpired and it is virtually impossible to do anything more at this point than conjecture about good or bad practices.

However, there are real lessons to be learned here, not the least of which is the urgent need for a rigorous and independent assessment of a fund's risk management and valuation practices, policies and controls (if it is not already being done).

Let's be very clear. This notion is not specific to any particular fund but rather a prescription for investment decision-making in general. Is it true that some investments are considered ex ante riskier than others and thereby demand more scrutiny? Yes. Is it true that pension fiduciaries have ultimate oversight authority? Not speaking as an attorney (and urging readers to check with counsel), oversight is a critical task. Is there a possibility that real people could lose real money? Yes. Is revisiting the money manager selection and review process - emphasizing risk management and valuation issues - time well spent? Yes. Is there any reason not to get started right away? No. posted by Susan Mangiero at 9/20/2006 12:04:00 AM