Amaranth's $6.6 Billion Slide Began With Trader's Bid to Quit

Nicholas Maounis, founder of theAmaranth Advisors LLC hedge fund, made a decision in April 2005that eventually cost him his firm. His promising natural-gas trader, Brian Hunter, had beenoffered a $1 million bonus to join Steven Cohen's SAC CapitalAdvisors LLC. Maounis, who had built his Greenwich, Connecticut-based fund to $6 billion in assets, didn't want Hunter to go. Convertible bond and equity prices were falling and oil andnatural gas prices were increasing, making Hunter's expertisemore valuable. So Maounis named Hunter co-head of the energy deskand gave him control of his own trades. Hunter, within 17 months, would be responsible for $6.6billion in losses, detonating the biggest hedge fund implosionever. Since Amaranth's sudden collapse, investors have questionedthe unusual trust Maounis put in his star trader, now 32. Theysay Maounis gave Hunter too much latitude and that Hunter,trading more than half the firm's assets, was blinded by a betthat had worked like a charm for two straight years. ``Amaranth's demise is not due to some complicatedquantitative reason -- it's about human failing and frailty,''says Hank Higdon, who runs New York-based Higdon Partners LLC, arecruiter for hedge funds and other money-management firms. Hunter declined to comment for this article when contactedDec. 4, and Maounis, 43, declined to comment through a spokesman.

Billions Lost

Tallying the final days of Amaranth involves huge sums:During one week in September, Hunter's bet on natural gas lostabout $4.6 billion. By month's end, the losses totaled $6.6billion, or 70 percent of Amaranth's assets. At least one investor saw serious warning signs about thebig energy bets and pulled out before the collapse. Some formeremployees -- who, like others familiar with Amaranth'sunraveling, spoke on condition of anonymity because the fund is aprivate company -- also say they raised questions about theextent of that wager. When an abrupt market reversal left the fund facing enormouslosses, it was too late to unload positions.

`Blood in the Water'

``When you know someone has such a big position, it's likeblood in the water,'' says Mark Williams, a Boston Universityfinance professor and former risk manager at electricity traderCitizens Power in Boston. ``Amaranth had exercised its muscle in the market when theywere up, and now the tables were turned, and the market wasexercising its muscle against them.'' Market conditions weren't ideal in 2005, either, whenMaounis negotiated with Hunter that April for an enhanced role atthe firm. Amid the discussions, convertible bonds, once amainstay for Amaranth, tumbled. In the first five months of 2005,convertible bond funds fell an average of 6.5 percent, accordingto Chicago-based Hedge Fund Research Inc., as the difference inyields between corporate and government bonds narrowed andvolatility in the stock market dropped to a record low. Amaranth's credit bets suffered after Standard & Poor's cutthe credit ratings of General Motors Corp. and Ford Motor Co. tojunk -- or below investment grade -- in May 2005, and its equitypositions weren't making money, either, two former portfoliomanagers at the firm say. Maounis, who often sat on the trading floor in Greenwich,looked to Hunter for rescue because his natural gas and otherenergy trades were successful.

`Do Something'

``Do something,'' former traders quote Maounis as sayingwhen Hunter walked by. ``We need you.'' Hunter obliged. Investors and Amaranth employees say his bigscore came in September 2005, when the natural gas bets he hadplaced earlier in the year made $1 billion in the wake ofhurricanes Katrina and Rita as he correctly wagered that priceswould increase. The hurricanes -- Katrina hit the U.S. Gulf Coast on Aug. 29and Rita followed on Sept. 24 -- limited gas supplies, pushingprices to a record $14.20 per million British thermal units onSept. 29. That was when fellow employees started learning more aboutthe low-key, 6-foot-5-inch (2-meter) Hunter, a Canadian whosometimes wore jerseys of the National Hockey League's CalgaryFlames on the trading desk, colleagues say.

Convertible Bonds

Maounis, a former convertible bond trader, opened Amaranthin September 2000 with $600 million in assets and the goal ofoperating a multistrategy hedge fund like Kenneth Griffin's $12.8billion Chicago-based Citadel Investment Group LLC, Amaranthinvestors say. Griffin built one of the largest hedge fund firmsin the world with returns that averaged about 25 percent a yearsince 1991, according to investors in the funds. Amaranth's assets totaled $7.5 billion by the end of 2005,making it the world's 39th-largest hedge fund, according to HedgeFund Research. Its clients were some of the biggest institutionalinvestors, including funds run by Goldman Sachs Group Inc.,Morgan Stanley, Deutsche Bank AG and Bank of New York Co.'s IvyAsset Management Corp. Pension funds of 3M Co. of St. Paul,Minnesota, and the San Diego County public employees also signedon. Amaranth grew with the industry. Hedge funds -- looselyregulated, private pools of capital that allow managers toparticipate substantially in their investment gains -- managed$1.1 trillion at that time, more than double the amount of fiveyears earlier, according to Hedge Fund Research. As the hedge fund field became more crowded, traderscomplained that everyone was trying to take the same positionsand that market inefficiencies, which the funds exploit forprofit, were disappearing.

Leeway for Traders

Amaranth sought profits in shares of merging companies,distressed debt and stocks. It made a push into energy trading in2002, hiring former Enron Corp. trader Harry Arora to lead theeffort. Maounis's style was to focus on raising money frominvestors, deciding how it should be allocated and hiring thebest traders he could find. He didn't micromanage, preferring togive more leeway to traders who did well, former employees say. Maounis knew who was making and losing money, though hemostly left the details to department heads and the riskmanagement team headed by Rob Jones, Amaranth investmentprofessionals say. Jones declined to comment through a spokesman. Using this model, Amaranth had 15 percent annualized returnssince its inception -- more than double the average performanceof multistrategy funds for the same time period, according toHedge Fund Research.

Arbitrage

Maounis, who graduated from the University of Connecticut in1985 with a finance degree, started his career at investment bankLF Rothschild, Unterberg, Towbin and hedge fund Angelo, Gordon &Co., both based in New York. In 1992, he joined Greenwich-based Paloma Partners LLC andeventually traded $400 million, the largest amount managed by anyindividual at the hedge fund. ``At Paloma, Nick had a stellar reputation as a consistentperformer in convertible arbitrage,'' says Leon Metzger, a formerPaloma executive who is a lecturer in finance at Yale Universityin New Haven, Connecticut. After eight years, Maounis left to form Amaranth with 27employees. The stocky, 5-foot-9-inch former trader created a pleasantenvironment for employees. Amaranth's offices featured a gym; agame room with pool tables, foosball and air hockey; and a musicroom with electric guitars and drums so people could jam. Thetraders and investment managers wore costumes at work forHalloween.

Mathematics Degree

Hunter, who grew up near Calgary, had earned a master'sdegree in mathematics from the University of Alberta beforestarting to trade natural gas in 1998, according to Amaranthmarketing materials. He traded for Calgary-based TransCanada Corp., then joinedDeutsche Bank in New York in May 2001. In his first two years, heearned $69 million for the bank, according to a complaint Hunterlater filed in New York State court in Manhattan that claims thebank owes him bonus money. Ted Meyer, a Deutsche Bank spokesman, declined to comment onthe suit. Deutsche Bank filed a motion for summary judgment lastweek, saying Hunter's bonus was at the discretion of bankmanagers. The lawsuit is pending. By 2003, Hunter was head of the bank's natural gas desk. ``Brian was always very open to talking about the market andgiving of his knowledge,'' says former Deutsche Bank colleagueBruno Stanziale, 34. ``He has an understanding of the market thatothers do not.''

`Unforeseeable Run-up'

In December 2003, Hunter and his colleagues were up $76million for the year. In the first week of the month, however,the desk lost $51.2 million after an ``unprecedented andunforeseeable run-up in gas prices,'' according to Hunter'slawsuit. Hunter says in the suit that even with the loss, he made $40million for Deutsche Bank that year and more than $100 million inthree years. Hunter left Deutsche Bank in April 2004 and joined Amaranthshortly thereafter. The first domino in Amaranth's demise fell a year later whenHunter told Maounis about the job offer by Cohen's $8.5-billion,Stamford, Connecticut-based hedge fund, the 23rd-largest byDecember 2005, according to Hedge Fund Research. Former Amaranthemployees with knowledge of compensation agreements say Maouniscountered by giving Hunter more trading authority. By the end of 2005, Hunter was the highest-paid trader atAmaranth, the former employees say. Under his new deal withMaounis, Hunter earned 15 percent of any profit he made, whilemost traders made an average of 10 percent.

$75 Million Earned

Like many other employees, he put a third of his bonus inthe fund, which vested over three years. In 2005, Hunter earned about $75 million, primarily from hisKatrina bet, compared with about $4 million in 2004, theemployees say. At the end of 2005, Maounis let Hunter move his wife and twochildren back to Calgary and open an office with eight traders. Yet at least one potential investor visiting Amaranth atthat time was concerned the fund's energy holdings were toolarge. ``It looked to us like the Amaranth multistrategy fund was apure energy bet,'' says Edward Vasser, chief investment officerof Wolf Asset Management International LLC, a Santa Fe, NewMexico-based fund of funds. ``Almost all of their profits camefrom their energy portfolio.'' He decided against investing in Amaranth.

Assets in Energy

Still, the energy bet was working for Amaranth, which hadabout 30 percent of its assets in the sector. The flagship fundended the year up about 15 percent, compared with Citadel's 7percent. In January 2006, Maounis allocated $1 billion to Hunter, whothen made $300 million during the next four weeks, formeremployees say. The wager had been essentially the same since Hunter joinedAmaranth. He was betting that the difference in prices of naturalgas between winter months and summer months would widen. Wintermonths were represented by March delivery contracts and summermonths by April contracts. He placed these trades going out until 2012, say marketparticipants with knowledge of his positions. The spread widenedto more than $2 early this year from about 40 cents when Hunterstarted at Amaranth in 2004.

Betting on Oil

Hunter also bet that natural-gas prices would increase whilefuel and heating oils either would stay the same or fall. Arora, Hunter's former boss and the trader with the mostknowledge of energy markets at Amaranth, quit in March to starthis own fund. In April, Amaranth's fund climbed 13 percent, almostentirely because of energy trades, according to investors. In thefirst four months of the year, when other multistrategy fundswere up an average of 5.3 percent, Amaranth's returns approached30 percent, they say. Some investors were troubled by the fund's concentratedwagers. Executives of Blackstone Alternative Asset Management,the fund of hedge funds unit of New York-based Blackstone Group,went to Calgary in May to visit Hunter and afterward pulled theirentire investment, says a person familiar with the situation whospoke on condition of anonymity. A Blackstone spokesman declinedto comment.

Narrowing Spread

Former employees also say they were concerned about thepossibility of large losses. Some say they questioned Maounis andJones about Hunter's gamble and were told that the wagers weren'tparticularly risky because it was an arbitrage --profiting fromprice disparities -- rather than a directional bet on naturalgas. In May, Hunter's fortunes changed. Spreads between Octoberand January contracts, another way to wager on price differencesbetween warmer and colder months, narrowed to $3.27 from a highof $3.64. Spreads between March and April contracts alsonarrowed. Hunter lost $1 billion. Jones and Maounis asked other traders, in areas like stocksand convertible bonds, to cut their positions to raise cash,former employees say. Amaranth's paper profits in natural gas were significant,yet it couldn't realize all of the gains selling. Traders andhedge funds knew Amaranth was desperate to get out of its trades,so they wouldn't pay current prices.

Flights From Calgary

Word spread within the firm that Hunter had lost big, andother Amaranth traders say they assumed that he, Maounis andJones would reduce the exposure to natural gas. Hunter controlled 56 percent of Amaranth's assets andaccounted for 78 percent of its performance as of June 30,according to a July report to investors obtained by BloombergNews. Starting in May, Hunter and his team spent most of thesummer flying between Calgary and Greenwich to meet with Jonesand Maounis, colleagues who saw them in Greenwich say. Theyconferred almost daily at 4 p.m. Eastern time, either in personor by phone or videoconference. From June to August, the energy and commodities positionsearned $1.35 billion, Maounis told clients on a Sept. 22conference call, according to a transcript provided to BloombergNews. Much of those gains were generated in August.

Surging Inventories

On Sept. 14, though, the funds lost $560 million whennatural gas prices tumbled 10 percent as surging inventories andcooler weather cut demand for air conditioning. The spreadbetween March 2007 and April 2007 contracts collapsed to 63 centsfrom $2 at the beginning of September. ``We had not expected that we would be faced with a marketthat would move so aggressively against our positions without themarket offering any ability to liquidate positionseconomically,'' Maounis said in the call. ``We viewed the probability of market movements such asthose that took place in September as highly remote.'' Jones asked traders to liquidate their positions.Convertible bonds, equities and European loans all were sold tomeet margin calls. Yet the fund continued to need cash to meetmargin calls on its energy trades.

`Continuing in Business'

During the weekend of Sept. 16-17, Goldman Sachs, CitigroupInc. and JPMorgan Chase & Co. went to Greenwich to look atAmaranth's energy holdings. JPMorgan, one of the fund's brokers,and Citadel took over the natural gas positions on Sept. 20. With a loss already estimated at more than 35 percent forthe year, most hedge fund investors expected Amaranth to close. Yet on Sept. 22, Maounis told his investors: ``We have everyintention of continuing in business.'' In the following days, though, some fund managers sayMaounis was unable to make decisions as simple as giving them thego-ahead to sell their positions. Other Amaranth executives sayhis indecisiveness stemmed from his focus on the bigger issue ofhow to keep Amaranth going. The night of Sept. 26, Maounis sent a four-sentence e-mailto his 420 employees.

`Spirit Will Live'

``I want to thank all of you for your years of loyalty andsupport, especially during this especially difficult time for allof us,'' it began. ``I am quite sure that the Amaranth spiritwill live on in all of us as nothing can ever take that away fromus.'' Employees say they were shocked and also concerned aboutMaounis's state of mind. Within an hour, Stanley Friedman, head of human resources,sent out his own message explaining that Maounis's e-mail ``wasnot intended to say goodbye'' or suggest that the firm wasclosing. Three days later, though, the inevitable happened. Investorswanted their money back, so Maounis agreed to liquidate the fundsand return cash to his clients as assets were sold. The biggest hedge fund collapse in history didn't shutterAmaranth instantly, and no investors have sued. Most of thefirm's employees are gone, including Hunter. Amaranth moved to help place many of them at other hedgefunds. Maounis and key executives are overseeing the sale of thelast assets. In Calgary, Hunter is still building a new home for hisfamily, and people familiar with his plans say he's talking aboutgetting back to trading. ``He will find a way to get involved again,'' says formerDeutsche Bank colleague Stanziale. ``Otherwise, it would be toomuch intellectual capital wasted to have him on the sidelines.''