Answer: their investors.

Before you roll your eyes, hear me out on this. I have some very specific experience with this, as I have spent the past 18 months or so traveling around the United States, speaking with  my limited partners (i.e., investors) and with potential investors for our hedge fund.

My experience with this is why I have been watching the unfolding debacle at Amaranth Advisors’ with some bemused detachment.

Hedge_funds_rank
Now, without revealing any specifics, I will tell you we have had conversations with some very intelligent people who were a pleasure to meet with; Brilliant, fascinating, successful folk with interesting lives and of great accomplishment. However, once we sat down with their financial advisors – lawyers – accountants, things became, well, repetitious. In every meeting, there were some variations on the same conversations; Its like there is some hedge fund due diligence form that makes everybody ask nearly identical questions:

What’s your track record?  (Good)
How much skin do you have in the game? (alot)
How is Alpha generated (our models keep us on the right side of the major trend, and avoid big counter-trend moves)
What do you think will happen to the economy and the market?
(I don’t know, but here’s an underappreciated possibility . . .)
What is your Gamma ? Sharpe Ratio?  (I neither know nor care; This isn’t a B-school exam)

Then comes the exact same question, which I  (foolishly) answer honestly:

"What sort of performance are you looking for?"

I usually start with: "It depends upon what the market offers us; If we remain range-bound, it will be difficult to put up great numbers without a lot of leverage or a lot of risk (or both), and we don’t do that. We do particularly well, however, in major dislocations or strong rallies."

My initial answer is rarely accepted, and I am forced to go to a 2nd and 3rd option:

"Give us more details on what you want to do. What performance would you be happy with?"

Answer two:  "What we want is irrelevant; Its what we can reasonably do while still managing risk, and not overleveraging. Our goal is to outperform the S&P500 with less risk, and in the event the SPX is negative, still have positive expectancy (i.e., be up when the indices are down)."   

"So you are a relative (rather than absolute) performance fund?"

Answer 2b: "Well, most funds actually are, despite their claims of absolute performance regardless of market conditions. Consider the mediocre performance numbers from most funds recently when the market’s been range-bound. Its been pretty weak, and that’s no coincidence. There are only a handful of true absolute performance funds with great long term track records (and if you are talking to me, its because you cannot get into them)."

Now comes THE QUESTION. This is the one that gets people into trouble:

"We are looking for a number. What should we expect from you in the first 2 years?"

What they want to hear is "I am going to do 30-40% annually, fully hedged."

I don’t say that, because it isn’t true. (God bless Jim Simons, who actually can honestly say that). That’s what too many investors are looking for; its nothing more than the greed factor at work.  They don’t say it explicitly, but its true: We want you to outperform the long term S&P500 benchmark by 300-400% annually (and we don’t care about mean reversion). We really don’t care how you do it. We want outsized profits. WE WANT THE LATE 1990S AGAIN.

Money raisers and some GPs have long ago figured this out. You have a few choices: you can answer the investors’ questions honestly — or to quote Ray Davies, you can give the people what they want (or think they want):

"We expect gains of 35-45%, with minimal risk or leverage. Our black box algorithms  have been backtested, and generate better numbers than that, but we would rather under-promise and outperform."

2_and_20_1
Of course, that statement will be nonsense for 99.8% of the people who utter it. The vast majority of funds will not out-perform the indices dramatically year after year. We were fortunate — we ended up with investors who understood this; Then again, we are a small fund, and not a $9B giant.

There are some funds that aim to fill this niche. They use lots and lots of leverage, play the highest beta moves, load up on derivatives, put up good numbers for a stretch. Eventually, they do one of two things: They take on some risk management — lower their volatility plays, reduce leverage, aim for more sustainable gains.

Or they blow up.

Not all of them, but enough. Something like 25% of all hedge funds every couple of years dissolve, go away, reform, pop up elsewhere. That’s not a coincidence, either.

~~~

So Amaranth put up great numbers for a while. And now we know how they did it: They took extraordinary risks, using lots  of leverage on the highest beta trades. And when one went against them, it blew up, and they lost a few billion dollars in a week.

Don’t blame them. Their investors demanded huge returns, and they turned a blind eye to the inordinate amount of risk required.

Who is to blame?

I think you have a suspicion as to who I think is the cause of Amaranth’s losses . . .

Category: Commodities, Investing, Markets, Psychology, Trading

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

73 Responses to “Who’s to Blame for Amaranth’s Losses?”

  1. Steve Colglazier says:

    Thank heavens! Breath of fresh air. We are in the same business and it is exactly like this (if not worse). It may seem hard to say the right things up front, but we have found that if you do, you tend to get the types of investors you want to keep.

  2. Exactly — if someone says to me “We want to see a 5 year track record”, or “we dont do emerging managers,” or “we already have Macro exposure,” I am perfectly cool with that.

    But when they say — no, you are too realistic, we don’t want that, we want 30% year over year regardless, well, what can you say to that?

    The obvious performance sluts end up getting exactly what they want — and we saw that with Amaranth …

  3. Uncle Jack says:

    Hey, that’s like blaming the girl who spilled her hot coffee for not exercising personal responsibility to keep it from spilling. Holy cow.

    Or smokers for getting cancer.

    Or over-eaters for getting diabetes because they’re fat.

    They want risk? Give ‘em risk.

  4. joe says:

    Somewhere in Greenwich, Nassim Nicholas Taleb is laughing hysterically as yet another set of traders were “Fooled by Randomness”. The story of Brian Hunter is the story of John Merriweather and the story of Victor Niederhoffer and every other trader who made lots of money for periods of time only to find out that any string of numbers multiplied by 0 is still 0.

  5. Gunther says:

    If some greedy people loose money, so what. The possible bigger effects get me worried. When will the next LTCM happen?
    Anyway, Amaranth is a good case to show that it is better to respect the risk in a trade and avoid too much of it.

  6. christopherrobin says:

    will more hedge funds be blowing up … look at the decline in OIL.

  7. Russell says:

    If a fund lies and tells people that they will earn 30-40% fully hedged then they are at fault.

    Hedge funds trying to accumulate money are not the first people to run into the problem of unrealistic expectations. If honesty was always profitable, then nobody in business would ever lie. The fact that there are foolish people with lots of money does not condone lying.

    In the case of Amaranth, they may have been incompetent rather then lying.

    Russell

  8. jmf says:

    hello from germany,

    fantastic barry.

    what really scares me is that the main players in this minefiled like goldman sachs were up on the news.

    a huge portion of their business depends on the hedgefunds and their own trading / own funds.

    you would assume that at leat the big blow up would take the stock down a bit.

    maybe the blow up was not big enough. the next one is coming for sure…

    http://immobilienblasen.blogspot.com/

  9. Uncle Jack says:

    This story is no different than Gleeson bringing down Barings; a guy got caught on the wrong side and instead of owning up, he martingaled his way to the poor house.

    It’s one thing to hold on too long to a loser (a common mistake), but quite another to keep doubling down on that loser.

  10. Bill says:

    Barry, well said. I have been a broker/money manager for 25 years. Your experience with client expectations has been my experience as well.

    I too refuse to compromise my presentation to get money in motion my way.

    On a personal level: at the end of the day in this business my goal is to keep clean my reputation and name.

  11. blam says:

    The quest for outsize performance should be a personal choice and should entail higher risk. That is a cardinal rule in a legitimate system.

    In this cycle, commodities are one of the primary arenas of massive speculation by funds of all stripes and varieties who have been “at work” seeking outsize gains. And most have gotten them as “risk (speculative)” premiums have driven up the prices of oil, base and precious metals, natural gas, etc.

    The more obvious losses from a hedge fund masks the diffuse losses that mom and pop have suffered over the past several years in higher prices, distorted economic allocations, higher interest rates, untenable mortgage schemes, etc.

    Any time the Federal Reserve provides excessive monetary stimulation and market regulation is insufficient to limit leveraged control by speculators, it is everyone who suffers the losses. The transfer of risk from the financial community to the population at large, with official support, lands on the general population far more than some silly ass hedge fund.

    The stage is set for a slow down and probable recession to re-balance the risk/return equation. Everyone pays. Just ask Japan. Thanks for the blog.

  12. Michael says:

    Anyone want to guess when that house of cards FNM blows up?

  13. andiron says:

    I think in 2-3 yrs hedge funds will be sweet memories..finance-driven markets meet only one fate: Death. These are leaches who suck blood from good, hard working people….

  14. Amaranth’s biggest mistake was messing in a field it knew little about — namely natural gas futures. The company’s roots are in convertible bond trading, which is a whole other ballgame.

  15. A friend who is a long time manager tells me: YOU GET THE CLIENTS YOU DESERVE.

    There’s some truth to that.

  16. Bob_in_ma says:

    But there are victims. There are the poor schmoes who got suckered into these “funds of funds” over the last couple years–the opportunity to invest in the most mediocre funds and with not just one, but two levels of outrageous fees! But then, maybe they aren’t victims either.

    Of course, there are the people whose pensions are in these things. I read the San Diego County pension fund was in Amaranth and I believe there was already a scandal about them being under-funded.

  17. James C. says:

    “Don’t blame them. Their investors demanded huge returns, and they turned a blind eye to the inordinate amount of risk required.”

    Yes, but whether investors can be fully aware of the specifics of the risks involved is another issue altogether. These involved not only the type of bets Amaranth was making in this case, but the controls it had in place for mitigating losses if these bets went bad. Amaranth appears not to have fully understood its own risks, and its investors were being provided optimistic risk control assessments. Whether there should have been greater appreciation for this additional form of risk, that is, that your fund may be overly optimistic with regard to its own risk assessment, is a matter of debate.

    We may see this debate take place in the days and weeks ahead in the case of Amaranth.

  18. Fred says:

    How can responsible, conservative investors get a reasonable return on their investments – with predictable risk – when some drunken bozo is crashing through the party breaking all the furniture? I believe LTCM, Refco, and now Amaranth have effects beyond their own clients.

  19. scorpio says:

    but u see the WSJ article this morning: both Morgan Stanley and Goldman Sachs funds (presumably the smartest guys in the room) had 5% of their money in Amaranth!! stunning to me that there isnt more fall-out in the market. if they can lose it here, they can lose it anywhere. if i were an investor i’d be banging on the door trying to get my money out. but apparently no-one really loses money any more, they have off-setting derivatives in place to protect. no losers, only winners

  20. wcw says:

    Even Simons has effects. Entirely eschewing folks with backgrounds in the field may help him put up great quant trading models, but I have seen his SEC filings pop up as long in some really abysmal names. That said, by all accounts his funds continue to crush the market year after year, so I can’t criticize. Sometimes you make a ton of money long really abysmal names; I just can’t bring myself to do it.

    Hunter made his nut ($100m last year, I believe) and will probably get hired again on top of that, so I can’t fault him, though there is no way I would have been pressing the aggressive long in March/April NG spreads he apparently had. Like Leeson, apparently Hunter had become an in-joke among NG traders, but why should he care? His children will die rich.

    Amaranth themselves bear some culpability. They appear to have bought Hunter’s line that he was managing his risk. A good risk desk never, ever trusts a trader. Which, of course, brings me to Barry’s point.

    The investors absolutely bear ultimate responsibility. They shouldn’t have been asking so much about returns, and should have been asking about the management and the risk desk.

  21. Wood says:

    Barry,

    FANTASTIC POST. As a PM with a long-term track record, I can tell you that we’ve left a lot of potential money on the table over the years by being stringent in who we took on as LPs. That’s been a conscious decision, and a sometimes difficult one to make, but we have always maintained that we have to be absolutely honest in our approach and if HONESTY isn’t good enough to interest the LP, they’re not an LP we have interest in.

    My first reaction when Amaranth blew up was, how could the diligence efforts of any LP that was TRULY focused on risk have accepted Amaranth’s trading policies? I can’t envision a risk/payout curve whereby there was an implied payout that justified the coincident risk there.

    Jason

  22. Michael C. says:

    >>>Of course, there are the people whose pensions are in these things. I read the San Diego County pension fund was in Amaranth and I believe there was already a scandal about them being under-funded.<<<

    I found this on the web regarding the San Diego County Employees Retirement Association. Of the $6.5B, “it allocated $175 million each to D.E. Shaw & Co. and Amaranth Advisors in addition to giving $125 million to Silver Point Capital. In so doing, the fund demonstrated that it has deepened its level of understanding vis-à-vis individual hedge fund strategies, choosing Amaranth for its arbitrage approach…”

  23. BDG123 says:

    I blame the hedge funds and the government for allowing these funds to exist without strict regulation. Hell hath no fury……………

    This whole hedge fund debacle will blow up because there is no regulation. The ironic thing is the best way to legitimize the industry is to regulate it. Yet, the industry refuses to support. Ultimately, those reasons are highly suspect as it pertains to the potential investor.

    I’m not throwing everyone in the same boat but since there is no regulation, do I really have any other choice?

  24. James C. says:

    “The investors absolutely bear ultimate responsibility. They shouldn’t have been asking so much about returns, and should have been asking about the management and the risk desk.”

    And perhaps some or even many were, and perhaps faulty and/or misleading information was being provided in response. We don’t know at this stage, which is why so much of the discussion for now is speculation.

    Let’s see how this plays out going forward (including the response of investors, who may feel they have legal recourse).

  25. bold'un says:

    An interesting point you make about 25% of hedge funds blowing up every 24 months. I wonder whether that statistic (if statistic it is) should not affect the hurdle rate at which successful managers start to make their 20% peformance fee?
    Of course the very culture of performance fees is likely to encourage make-or-break concentration. Now that Corporations are expected to expense the cost of options granted to management, is there not a case for the hedge fund industry expensing the cost of the implied option involved in a performance fee?

  26. ~ Nona says:

    It would be useful if more people understood that returns as “small” as a single percent above an average, if earned year after year, become quite gratifying total returns — and with less risk.

    Good money managers (Barry: take a bow) generally deliver better than a single percent compounded annual return year after year. Just a few percentage points above the “average” is, in fact, an impressive return over time — something I wish I had understood a long time ago.

    Maybe those of you who are money managers might make it a point to help clients and would-be clients understand this. The understanding would help to temper that natural, normal human yearning for…a free lunch. And need I mention that, in the long run, this shared understanding would make your jobs a little easier?

  27. Whos to Blame?

    Barry Ritholtz has a more than a little inside experience in the hedge fund game, and when it comes to the Amaranth debacle, he says that you cant place all of the blame on the fund or their energy traders. A lot of the blame must go to the inv…

  28. Lex says:

    Of course the investors should bear responsibility. If they wish to suspend belief and trust their $$$ to hedge funds, that, essentially, can put it all on red, they get what they deserve. That principle will not prevent politicians from making hay out this latest hedge fund meltdown. CT’s AG, Richard Blumenthal, has called (for about the 10th time) for the State to regulate hedge funds. As if the problem is lack of oversight — the problem is lack of diligence in general and observance of fiduciary responsibilities on the part of pension mgrs., in particular.

  29. sean says:

    You go Barry…. Tell it like it is. And keep giving us the truth, it is absolutely refreshing.

  30. Mike says:

    From today’s Goldman Sachs 8-k: “…As of September 1, 2006, Amaranth accounted for approximately 1.73% of the Company’s overall net assets through the Company’s investment in Goldman Sachs Global Relative Value, LLC. The Company’s return for September is expected to be adversely affected due to its indirect investment with Amaranth, although the overall return for the Company will also be impacted by fluctuations in the values of its other indirect investments with other advisors…”

  31. Mike says:

    From today’s Goldman Sachs 8-k: “…As of September 1, 2006, Amaranth accounted for approximately 1.73% of the Company’s overall net assets through the Company’s investment in Goldman Sachs Global Relative Value, LLC. The Company’s return for September is expected to be adversely affected due to its indirect investment with Amaranth, although the overall return for the Company will also be impacted by fluctuations in the values of its other indirect investments with other advisors…”

  32. ignorant says:

    For managers and investors : When hedge funds claim to have a certain track record, what they have to show are beautiful spreadsheets and slide shows that nobody can verify ?

  33. S says:

    Just as night follows day, hedge fund investors must periodically re-learn two lessons: 1) VAR is a theoretical concept; 2) Leverage ain’t always good.

  34. John F. says:

    Answer: Satan.

  35. ignorant says:

    Guys, please tell me that someone besides Satan can verify the performance of un-registered (SEC) hedge funds…

  36. lauteus says:

    Give a crack addict a pound of crack based on his/her “track record” and see what happens.

    Some of these hedge funds are nothing more than a “community” of greed following greed from the performance bonus to the questions about returns by potential investors without any checks other than those put forth by the greedy… This “club” has been able to drive prices through the roof in a collective manner stripping $ from everyday consumers… at what point does the scale tip to market control. Imagine the top funds playing cards together next week, without control it will come to that…

  37. ignorant says:

    What do you guys tell me about Millennium Partners ?

  38. abe shorey says:

    “A good risk desk never, ever trusts a trader.” Problem, there is no good risk desk. Talent on/for risk moves to trading. Leeson analogies are silly, there’s no rogue here. He did his thing, and blew up. Re legal recourse, highly unlikely. Hunter had a trackable record, and anyone who cashed in on his Katrina performance has no grounds to bitch now. Larry N. nails it, the fund’s managers were lost in natty. They chased the return, got burned. Old story.

  39. V L says:

    Were they so desperate for business as to accepting clients with unrealistic expectations and driving in a fast lane? Maybe it was secondary to management greed, arrogance, lapse in judgment and failure to adapt to changing market conditions. What was working for them in the past will not necessary work in the future. In 2006 market conditions have changed secondary to global economic contraction (characteristic by commodity prices coming down). It seems they were in denial of reality and thinking they were still in wonder world of 2005 economic cycle expansion.

    It should be 100% responsibility of the fund management for taking such astronomical risks without damage control measures in place and not understanding the basic principles of economic cycle. The fund was making irresponsible high risk bets using other people’s money. The fund was accepting clients with unrealistic expectations, etc. The fund is responsible. The fund is to blame.

    P.S. There is another highly leveraged in commodities hedge fund in London. It will be taken away in the ambulance too if commodities continue sliding down – most likely they will.

  40. S says:

    ignorant:

    They are audited before performance fees are paid. (In the case of Bayou, I believe the auditor was not completely unaffiliated from the manager!!)

    Marking illiquid securites often entails judgment. The easist example to understand is a smallish corporate bond issue. After issuance, it may rarely (sometimes never) trade, yet the PM has to mark it to market. If it doesn’t trade, how do you know what the market for it is?

    The bigger issue involves the $26 TRILLION derivatives market. Granted, that market has evolved and there are enough banks and counter-parties involved that a market can usually be determined for the “standardized” contracts. But some derivitives are tailor made between two parties. Marking those involves alot of judgment.

    A GOOD hedge fund manager will have a written policy about the assumptions used to mark the illiquid securities in its book. A GOOD investor will ask to see that policy prior to investing with the manager. A GOOD auditor will test to determine that the policy was applied consistently and that it is reasonable.

    In the real world, not everyone is good.

  41. Joe says:

    I’m so glad to hear you mention “greed” because thats exactly what these guys have. I’m a kid in his mid-20s looking at barely 5-figures in the market, because thats all i got to work with. And these folks have upwards of 7- or 8- figures to play with? It blows my mind that they need to beat the market. At their level, I can’t understand why just staying with the market isn’t good enough.

    Then again, maybe i’ll understand better when I have 7-figures….

  42. sell_the_ten_year says:

    Joe,

    These folks (Amaranth) have 11-figures in terms of unleveraged assets. (Ok, maybe they’re down to 10 after this gaffe.)

  43. M.Z. Forrest says:

    PSA:

    For investors wanting consistent returns while assuming little risk, fixed annuities are available.

    /End PSA

    On a serious note, if fund managers are going to state performance goals, they should be required to state them with a confidence interval. Two standard deviations should be sufficient. Of course if this were done, we would have to stop pretending that equities outperform all asset classes in the long run. Comparing the Dow return compounded over 8 years versus the Overnight Lending Rate compounded over 8 years with 40 time spans showed only 60% of the time the DOW outperformed the overnight. The average outperformance was 2000 basis points. Better to mention the latter number to the general public rather than the former.

    To be honest, I have little sympathy for those with fiduciary responsibility acting like they have none.

  44. Royce says:

    When I think “long term” in investing, I see something longer than 8 years. Something like 20 or 30 years is the time period I typically see cited in which equities have the best risk/gain when planning for retirement.

  45. M.Z. Forrest says:

    It depends on what the numbers are for determining the longterm. If stocks have been flat or down for 8 years, you take the 20 or 30 year number. The key is including the massive expansion in the 80′s when stocks exploded with higher interest raters. (The 90′s were had high returns on lowering interest rates.) In the 80′s the lowest overnight was 6.66 and the highest was 16.39. The feds fund rate hasn’t exceeded 6.66 since 1990. A dollar invested in 1980 would be worth $2.58 by the end of 1989 if you just got the fed funds rate. Similarly a dollar invested in the DOW in 1980 would be worth $2.28 by the end of 1989. So during the 80′s you had annualized gains of 8.6% which looks good until you compare it to cash.

  46. Royce says:

    According to what I see on Yahoo finance, the dow went from 824 on Jan. 2, 1980 to 2,753 on Dec. 29, 1989. I’m math challenged, but wouldn’t that mean a dollar grew to $3.34 over ten years? (and that’s not including the annual dividend yield you would have gotten from owning the underlying stocks)

  47. M.Z. Forrest says:

    (2753-824)/824. It appears you didn’t subtract the 824. The dividends don’t add much on the adjusted close basis. I’m not sure how Yahoo calculates the dividend and split adjusted lose, but it does not appear the numbers would be greatly affected by the numbers Yahoo uses for that. (I also used 838 as the start per Yahoo’s open in jan 1980.)

  48. Alex Khenkin says:

    Royce, you probably ment to say “have had”. Past performance, here I go again: Hold Stocks for 30 Years?

  49. GeorgeNYC says:

    I do not care what you all say, I want to be a hedge fund manager. I do not care how much “skin” you have in the game the “upside” of the good years is that you get to pocket some cash while the “downside” of the bad years just means that you lose most of it. But hey if I am up $100 million and lose $90 that is still $10 million in my pocket! Even if you are left with only a miilion (quelle horreur!) that is still about $950,000 more than the average joe sixpack whose pension money you have just lost.

    I know that one can claim that is is hard work and brilliance but that is just bull. As you so correctly point out, the big returns come form takingon big risk. It is not “heroic” or “brilliant” or “ballsy” or any of the other egomaniacal self-flattering monikers. It is just luck and a celebration of survivor bias.

    We are stripping our economy of truly productive assets. Our “best and brightest” are no longer making things or developing things of value but simply learning how to rape and pillage real assets and take their cut. I feel so old fashioned saying that. The problem is that the system seems to hold together and create the illusion of prosperity. There are so many voices out there talking about the dangers of such huge imbalances. But it is similar to the warnings about “terrorism” in that every day that passes without a true crisis just allows the bulls to claim that our economic system has evolved into a new economic order.

    I do not want a revolution. A true market economy, despite the creation of inequality at certain levels, should nevertheless reward true hard work and true inovation. It may not provide equality but there should be a certain “fairness.” That is not what we have now.

  50. Isn’t Amaranth another indicator of GBB (Goofy Boomer Behavior)? The generation that was formed during the greatest swelling of productivity and prosperity in the history of mankind unnaturally assumes, “It’s different this time.”

    Once again the wisdom of Will Rodgers applies, “It’s not the return ON your investment that’s essential, but the return OF your investment.”

    There are many more and larger icebergs in the financial shipping lanes than Amaranth. Don’t count on the helm’s men at the Fed or anywhere else to acknowledge their existence let alone chart a safer course for our global economic Titanic.

    What do we learn from studying history? That we don’t learn from studying history.

    Sigh,

  51. lauteus says:

    Who/what will be the modern day robin hood?

    Isn’t it all just a large tug-o-war with the hedge funds having the largest team…money doesn’t grow on trees…where are all of these billions and billions coming from… the small investor?

  52. royce says:

    mzforest:

    Ah, I see. Dividends probably would have accounted for 2-3% a year.

    Alex:

    Yeah, whatever. If you don’t trust Siegel’s analysis of the real return in stocks, you should invest in something else. Bonds, gold, real estate. The great thing about the market is that it lets each participant test theory against the real world.

  53. there they go again says:

    MZ Forrest.

    You’ve got an interesting math. Why subtract? You don’t lose your first dollar.

    A dollar invested at 16% in 1980 would be worth roughly 4 dollars provided you could get 16% on your interest. in 1990 (remember the rule of 72.)

    If stocks increased 3 times the buck would be worth 3. Plus there was dividends at nearly 8% in 1980 so just assuming you spend them and don’t reinvest there would be with increases a bit more than a buck more. If you reinvested you could do better, the 8 cents you got in 1980 would be worth 24 cents in 1990 not counting it’s retirns on dividends.

  54. Chuck Lieberman says:

    Were Amaranth’s investors culpable? Absolutely. Should Amaranth be absolved? That depends. Did Amaranth properly convey to their investors how risky their strategy was? If they did and the investors went in blinded by the promised or historical returns, then they were foolish and got what they deserved. But if Amaranth led them to believe that the risks were far smaller, that positions were hedged, that the expected returns were very large and the risks were not, no matter how gullible the investors were to swallow that story, then Amaranth contributed to the delinquency of minors and deserves to have the book throw at them.

    Another issue here is that the investors were supposed to be “sophisticated” qualified investors. It is somewhat contradictory to say that they were naive, yet they qualified as sophisticated. But from experience, those of us who manage money know it is a safe bet that plenty were awfully naive or gullible, did not do their homework and did buy the B.S. that the risks were managed. Clearly, a bad fit for the hedge fund business. My bottom line is both parties were culpable. Neither should be able to hide by blaming the other.

  55. alex says:

    Great post Barry – appreciate your take on that issue..it is pure greed that is the root of such events.

    mz forrest/there they go again:

    don’t forget you are talking about nominal values. You have adjust for inflation (cpi – not core): that was 125% from 1980 to 2000. And if someone like GeorgeNYC would have managed your money you would have been left with $0…

    one question though remains: what is capital actually? I mean do have have an ok understanding of capital and its function in the economy and its function in society? I don’t think we really understand it. So far we assume it is just another “good” and trade it like we trade spaghetti, ferraris, etc.

  56. M.Z. Forrest says:

    Apologize for the error there. The number I gave was rate of return, rather than FV. 16% would be a little high. I used the actual numbers from here. $1 compounded over that time by the fed funds rate for each year comes out to $2.57. A lot of the CDs taken out at 16% and such were recalled by the banks as interest rates dropped, so the possibility of having a cash investment at 16% weren’t that high. Not to mention, it is easier to make an apples to apples comparison.

    $3.34 is certainly better than $2.57. Add another 24 to 50 cents for dividends compounding (if I do the spreadsheet, I’ll just do the dividend reinvestment at the beginning of the year, so 8 cents or so wouldn’t purchase anything until 2001.)

    My primary point was that the historical Dow return was calculated in an environment where competing investments offered higher returns, and as such relative performance to sticking money in a mattress is not the best way to predict future performance.

  57. royce says:

    I would never say that stocks always beat bank accounts or that the future rate of return over a given period is set in stone. Depending on when you buy equities vs. when you sell over even 20-year periods the real returns can vary widely. I just see stocks as a better bet to increase purchasing power into and past retirement 30 years down the road. If I had a huge liability coming up in 5-10 years, I wouldn’t count on the market to ensure the money is still there.

  58. Investors and Hedge Fund Risk

    Everyone should read Barry Ritholtz’s the honest and forthright description of how small hedge funds must interview for investors. He is exactly right about how the interviews go. I have many similar stories, but he has told it so well

  59. Barry Ritholtz on Amaranth’s Losses…

    Chances are, if you’re remotely interested in the world of investing, you’ve been as stunned by the news regarding Amaranth as I have. For those of you who don’t pay attention to the public equity markets with regularity, Amaranth was

  60. Investors, Mirror. Mirror, Investors.

    Barry Ritholz pontificates on who is to blame for the losses in Amaranth. I agree with him. It is the behavior and expectations of those who allocate funds to money managers that explains much of the behavior you see in

  61. Johnny V. says:

    I think the Dukes were behind all of this. Where the hell is Beeks?

  62. alexd says:

    I know I am asking for it but here it goes:

    First I found the above fascinating and actually agree with much of what has been said esp. BR’s observations. So please be gentle.

    But other wise I think you all are ignoring the elephant in the room.

    You all know either consciously or while you do the somnambulist waltz that it is not that hard to make a trillion dollars on your investments.

    It is the first 300 years that are tough.

    Back to the elephant. The problem is our life expectancy. Perhaps if we lived 5x in reasonably good health then lower rates of return would seem very attractive. We are all in such a rush to get whatever and wherever before the candle goes out. So perhaps we should start a foundation dedicated to supporting the science needed to achieve very long lives. Yes I know that a host of other problems would arise with this, but it sure helps with the compounding of assets.

    Greed is a form of mental illness. There is a reason it is included in the seven deadly sins. It is because it is bad for you. I am not talking about prosperity. I am talking about having sufficient (and I am not defining sufficient as my idea of sufficient.) and wanting more just as some sort of mental scorecard. The ever escalating desire that is actually a decent into a hell made on the pillars of avarice. It is to live with out peace. It is not about being rich. If you do something good, and make a lot of money then great. But if you buy a gorgeous Aston Martin and then get pissed because someone you know of got an even more expensive Ferrari. Then you are dammed. I asked a shrink what I could do because I was envious of those who simply were inherently smarter than I am. He said, “There is always going to be someone smarter than oneself. Or better looking or stronger or richer. It is our nature not to have every possible base covered. If you’re the richest guy in the world (HI Bill) then perhaps you are not the handsomest man, or have hemorrhoids, whatever, there is always something. But if you can learn to be happy, then perhaps you can use the money as a means to make the world a better place and in doing so make yourself happy too. The Buddhists say life is full of suffering and we should endeavor to end suffering. Makes for a purposeful life no? Plus you can still live very well. Warren buffet gave away approx. 47 billion dollars and will have to make due with 7.5 billion. Tough break.

    Back to the hedge fund situation.

    Did these guys ever hear of the concept of “Margin of Safety”? I suspect that as long as you make great percentage gains people forget about that. Besides the idea of a controlling trading desk perhaps another question is “What is your edge? If it is not defined adequately than it might not be there.

    Be well.

  63. Reader says:

    Amaranth is 1 of 8800 hedge funds — on the face of it, its blow-up provides little basis for drawing conclusions about this approach to managing money. How many Amaranths-to-be are out there? What dominoes might fall with them?

  64. Albert Ruback says:

    THE ARE BOTH TO BLAME.
    The fund managers are liars for saying they had risk controls in place when they did not.
    The “accredited investors” and/or their advisors were stupid to think they could get a free lunch – huge return for little/”managed” risk.
    It was a love fest when the beta worked for both of them on the upside, but now it is uncomfortable in the unraveling.

    Fun calculation: Just for grins, I did a calculation of how the investors in and managers of Amarynth did. Since I don’t know the real data, I assumed Amarynth started in 2001 with $2bn in capital, had a 2/20 fee structure and made pre-fee gross returns of 36%. In this scenario, the managers made total fees of $1.6bn, and the investors made $3.3bn in aftertax income. The problem is that the 55% drawdown this year is $3.9bn, meaning that the investors have $.6bn less than when they started. True, they will be able to apply this loss against other gains, but it is sickening to think that the managers(from their fees) and Uncle Sam(from the investors’ taxes) each made $1.6bn and the investor comes out 30% poorer after 5 years.

  65. diva says:

    I enjoyed reading your post Alexd (among many others)
    I am of the ‘slow and steady’ group…… and, at this point am happy with the accumulation of savings/investment earnings over 30 years,
    The ‘hard’ thing today (for me) is balancing my fear with my desire for continued returns. I do have 10% in a hedge fund as this is part of my diversified investment approach.
    I am a big believer in NOT having “all of my eggs in one basket” at any time, as no one gets it right all of the time.
    I think many investors would be better off it they remembered that simple concept.
    Tis much safer to never exceed 10% of your portfolio in any one investment class (except guaranteed things like Treasuries, of course)
    ….just my thoughts

  66. Andrew says:

    As someone who saw Amaranth’s #’s, I can remember having a conversation with my boss in April where I told him that if I were one of their investors and wasn’t stuck in a lock-up I’d get out right now. Nobody makes 12% in a month on 9b. Even JS/RenTech closed out Medallion at 4b ish.

    Any investor that still stayed in after the first quarter of this year, and had a choice about it, is an absolute moron that got what they deserve.

    It didn’t take a genius to figure out Amaranth was making enormous directional bets, regardless of what they were saying to their investors.

  67. me2200 says:

    “I do not want a revolution. A true market economy, despite the creation of inequality at certain levels, should nevertheless reward true hard work and true inovation. It may not provide equality but there should be a certain “fairness.” That is not what we have now.”

    Hunter made $100 million i pay last year. For what ? Betting on a commodity ! Where is the innovation in that ?

    This year he loses $6B. Any chance he has to repay last year’s $100M ? Probably not !

    Do you know how much R&D can be done for $100M ? Real, true innovation !

    I can’t believe that investors give these guys a huge bankroll to play with and then pay them handsomely for wagering it and then complain when they lose the bet. I’ll gamble with someone else’s money any day of the week !

  68. A says:

    I think we’re going a bit overboard on this topic. Keep in mind that the $4.5 billion that Amaranth lost, hasn’t really been lost, so much as it simply belongs to someone else now. (and the stock of those “someone else’s” is owned by a collection of institutional investors, just like the ones that lost money in Amaranth) Net-Net, joe sixpack’s pension money isn’t in a whole lot of danger.

    The interesting thing is how different this blowup has been compared to LTCM. No financial disaster, markets haven’t gone hay-wire. LTCM caused bond spreads to double almost overnight, all we’ve seen is a fraction of a basis point. In fact, it looks like the Thailand coup-attempt was bigger news in the financial markets.

    Sooner or later the investors will come to thier senses, and realized that there are a LOT of hedge fund closures each year, and that reaping 20-40% profits with zero beta is not possible without taking risk. (you might do it a few years in a row, but count yourself lucky)

  69. Let’s be crystal clear here: The Amaranth crowd gave the investors precisely what they asked for. They wanted very aggressive returns, and thats exactly what they got.

    Why place more blame with the investors? Because the funds work for them — not the other way around.

    Historically, whenever investors DEMAND unrealistic performance, they get spanked. Recent surveys show individual investors still think they can regularly capture 15-25% in the market . . .

  70. curmudgeonly troll says:

    So Barry, were you asking 2 and 20?

    If an institution is paying 2% of assets and 20% of profits, you make 30% and they get 24%. Going through a fund of funds will bring that down under 21% (1 and 10).

    Considering 5% risk free, 9% long-term stock market yields, and the obvious risks of HFs, it’s a vehicle that only makes sense if you think the manager is a miracle worker.

    Of course, if anyone thinks there are 8,000 miracle workers out there it just proves your point that any debacles are due to a triumph of greed over common sense, or (like second marriages) hope over experience.

  71. Econbrowser says:

    Amaranth hedge fund losses

    How in the world did hedge fund Amaranth Advisors manage to lose $6 billion in September on natural gas trading?

  72. hbs says:

    sorry for the late comment….but your article really makes me feel better…..i feel bad for the members of the retirement schemes…….or will the government(s) pick up the tab?…..which means taxpayers…..which means me……now i am depressed again….

  73. This looks good, too Good

    Readers of A Dash do not need us to tell them the old common-sense idea, If it sounds too good to be true…. Or so we would think. Meanwhile, those watching financial television are bombarded with self-serving ads from brokerage