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.''

Hedge fund managers can make you rich

Hedge fund managers can make you richquicker than just about anyone. Sometimes, they can make you pooreven faster. Just look at Amaranth Advisors LLC, the Greenwich, Connecticut-based hedge fund manager that stumbled over wrong-way bets onnatural gas. Going into September, Amaranth was up 26 percent in2006. By October, it had lost $6.6 billion. The next Amaranth is out there somewhere. Bloomberg News,using data compiled by Chicago-based Hedge Fund Research Inc. andBloomberg, has ranked the world's best-performing hedge funds insix investment strategies: emerging markets, distressed, eventdriven, long/short equity, fixed income and macro. Since 2000, the secretive world of hedge funds has more thandoubled in size. There are now more than 9,000 of these fundswith combined assets of $1.34 trillion. Everyone from Wall Streetchieftains to the stewards of retirement nest eggs is chasingthese funds, which are private pools of capital that allowmanagers to participate substantially in the investment returns theygenerate for clients. Investors poured a record $110.7 billion into these vehiclesduring the first nine months of 2006 -- more than twice what theydid in all of 2005. Since September, Morgan Stanley has boughtstakes in two hedge-fund firms and purchased a third outright.And since late 2005, Goldman Sachs Group Inc. has become the largestmanager of hedge fund money, with $29.5 billion in assets,according to HFR and Bloomberg.
Returns Sag
So many hedge funds have crowded into the markets that theindustry is struggling to generate standout profits. As of Sept.30, the average hedge fund was up 7.1 percent in 2006. Investorswould have made more money buying a mutual fund that tracks theStandard & Poor's 500 Index, which returned 8.5 percent throughSeptember. And while hedge funds typically charge a fee of 2percent of assets and take a 20 percent cut of profits, theVanguard Institutional Index Fund charges expenses as low as 0.025percent of assets. As money pours in and returns sag, Theodore Aronson, aprincipal of Philadelphia-based Aronson & Johnson & Ortiz LP,sees potential danger ahead. ``You don't have to go back to thetulip bulb mania to see how things could turn out,'' he says.``It could be ugly.'' Investors are coming to grips with slackening returns. Atthe California Public Employees' Retirement System, Senior InvestmentOfficer Christy Wood says hedge funds may have a hard time hittingher investment goals because of a rise in U.S. Treasury yields.
Hitting Targets
Calpers, which has invested about $4 billion in hedge funds,targets a return of 5 percentage points more than T-bill rates. In2003, that figure was 6 percent. On Nov. 8, with T-bills yielding5.1 percent, it was more than 10 percent. ``It doesn't take a lot of research to realize that you'regoing to have a harder time reaching that today,'' Wood says. Which hedge funds will deliver? One place to look for theanswer is below. There's no guarantee, of course, that thesefunds will make the list next time. ``For the rest of our lives, the developing world will becapturing an ever increasing slice of the global economic pie,''says Scott Peters, co-manager of the $82 million, Sausalito,California-based Tradewinds Fund LP. That theme, playing out in countries from Peru to Pakistan,has fueled white-hot performance of emerging-market hedge funds.
21 Percent Return
Such funds posted an average annualized return of 21 percentduring the three years ended on Sept. 30, more than any othercategory of hedge fund, according to HFR. During the first ninemonths of 2006, they returned 12.4 percent. Peters's fundreturned 54.2 percent annualized over the three years. Zeroing in on one market can bring even greater rewards --and risks. Peters's $132 million Tradewinds Russia Partners I LPreturned 80.2 percent annualized over three years. Peters calls that fund a wager that the political andeconomic landscape in Russia will continue to improve. ``Our bet in Russia has been that it would go from a reallychaotic situation to a less chaotic situation,'' Peters says.``It's actually done better than that.'' To hold down risk,Peters tends to invest in big companies that often have ties tothe government. And he uses no borrowed money. Other markets have proven almost as profitable as Russia. Bythe time Workers' Party candidate Luiz Inacio Lula da Silva donnedBrazil's presidential sash in 2003, many foreign investors hadrun for cover.
Betting on Brazil
Greg Lesko, manager of Deltec Emerging Market Equities LP, a$41 million New York-based fund, and his colleagues insteadpoured 10 percent of the fund's assets into Brazilian bonds thatwere trading for as little as 40 cents on the dollar. ``It was clear to me that Lula was not going to be atraditional leftist,'' Lesko says. In general, Lesko focuses on a dozen or so marketsbenefiting from what he sees as stable political situations,responsible economic policies and healthy competitiveenvironments. He began unloading the Brazilian debt a year or solater at 85-100 cents on the dollar -- when he was confidentenough to shift more heavily into equities. Today, 20.3 percent of Deltec is in Brazilian stocks. Thefund has also built up holdings in Taiwan, at 15.2 percent ofassets, and the Philippines, at 7.4 percent. Deltec was up 29.5percent annualized over the three years. Going against the crowd is the key to market-beating gains.Richard Mashaal opened Senvest Israel Partners LP in April 2003,during a wave of violence between Palestinians and Israelis.``Many stocks were trading below their cash holdings,'' saysMashaal who also runs a long/short equity fund. ``We felt thiswas the deal of a lifetime.''
Vultures Swoop
The fiasco at Enron Corp. has been good to Alan Cohen. SinceEnron went bust in 2001, Cohen, a senior managing director atYork Capital Management LLC, has made a fortune on its bonds. New York-based York Capital, run by Jamie Dinan, has emergedas one of the most-successful hedge-fund vultures. Its York CreditOpportunities Fund, which Cohen manages, posted an averageannualized return of 23.6 percent in the three years ended onSept. 30, according to HFR. In 2001, York bought bonds and shares of AdelphiaCommunications Corp., Tyco International Ltd. and WorldCom Inc --and got hammered when accounting scandals rocked those companies.York's main fund lost 7.1 percent in 2002. The firm held on tomany of those investments and posted a 33.3 percent return in2003. ``Many of these companies have continued to recover andgrow,'' Cohen says. ``We expect more positive developments downthe road.''
Troubled Industries
Hedge funds that trade distressed assets, typically junk bondsand corporate loans, posted an average annualized return of 14.6percent during the three years ended on Sept. 30, according toHFR. During the first nine months of 2006, these funds returned9.8 percent. So many hedge funds are chasing distressedinvestments that returns have withered from 18.9 percent in 2004. Sam DeRosa-Farag, president of New York-based Ore HillPartners LLC, says he's keeping a close eye on the troubledairline and auto industries. Cohen says he's watching them, too. ``You have 80 percent of the industry in trouble. That isquite unusual,'' DeRosa-Farag says of both. ``If you compare thatto the 1980s or 1990s, the pain threshold is much, much higher.'' As of mid-November, the biggest bond market casualty of 2006was Toledo, Ohio-based Dana Corp. The auto parts maker filed forbankruptcy on March 3, with $6.8 billion of debt.
Fallen Angels
More companies are likely to run into trouble soon,according to S&P. As of early October, 38 companies around theworld had lost their investment-grade credit rating in 2006.Forty-one more, with a combined $77.6 billion of debt, were atrisk of landing on the junk-bond heap. Bay Harbour 90-1 Ltd., managed by New York-based Bay HarbourManagement LLC, returned 34.6 percent during the three yearsended on Sept. 30, the best showing among distressed-asset fundsin the U.S., according to HFR. When Mirant Corp. made a $7.86 billion hostile bid for NRGEnergy Inc. in May, Barry Rosenstein, founder of Jana Partners LLC,went to work. Jana and several other hedge funds that boughtshares in Atlanta-based power producer Mirant denounced theacquisition as overpriced. The hedge funds won. Mirant eventually dropped its bid and,to placate investors, agreed to buy back $1.25 billion of stock. Over the past few years, hedge fund managers like Rosensteinhave made headlines -- and lots of money -- by buying stocks andthen pushing for change.
Provocateurs
Event-driven funds such as Jana Partners, which try to profitfrom corporate events such as mergers, acquisitions andbankruptcies, posted an average annualized return of 12.7 percentin the three years ended on Sept. 30, according to HFR. Duringthe first nine months of 2006, they returned 9 percent. As the S&P 500 Index rallied in November, some event-drivenmanagers predicted investor activism might wane. When stockinvestors are making money, it's often hard to rally them. ``The market is doing things on its own now,'' says JeffreyAltman, founder of New York-based Owl Creek Asset Management LP,whose Owl Creek II LP fund returned an annualized 16.3 percent inthe three years ended on Sept. 30, according to HFR. If the goodtimes last, investors may start to frown on hedge fund rabble-rousing, Altman says. Activists may have a harder time making money because somany hedge fund managers are piling on, says Rosenstein, whosefund posted a 19.5 percent annualized return over three years,according to HFR. ``You have a lot of people combing over the same companies,and stocks can be run up too high,'' he says. The plus is that thenew breed of hedge fund activist has provided a shareholder basethat supports corporate change, Rosenstein says.
Activist Action
Rosenstein has teamed up with some of the most-prominentactivists around. He joined billionaire corporate raider-turned-hedge fund manager Carl Icahn in a failed bid to break apart TimeWarner Inc. in 2006. Time Warner stock rose 12.6 percent in 2006through Nov. 8. At Owl Creek, Altman looks for companies that arerestructuring, spinning off units or struggling to boost theirstock price. He made money betting that auto industry suppliersand health insurance providers would ride out turbulence in thoseindustries. He also bought shares of AMR Corp. and Continental AirlinesInc., figuring the airlines would benefit from lower oil prices andrecent concessions from labor unions. ``Airlines are generating tremendous amounts of free cashflow,'' he says.
The Original Hedgers
In a world of rapid-fire traders, Richard Mashaal buys,holds -- and wins. Mashaal, manager of New York-based Senvest Partners LP,began buying shares of Msystems Ltd., a Kfar Saba, Israel-based makerof flash drives, at about $6 in 2001. Mashaal, 41, didn't sellwhen the stock doubled to $12 in 2003 or when it sailed past $30in 2005. Today, his $118 million fund still holds some 85 percentof its original stake in Msystems, whose shares traded at $35.38on Nov. 8. ``When you find a good management team with a good productattacking a growth market, you stick with it,'' Mashaal says. Long/short equity funds, which both buy stocks and wageragainst them, posted an average annualized return of 10.3 percentduring the three years ended on Sept. 30, according to HFR.During the first nine months of 2006, these funds returned 6percent.
Industry Giants
Investors poured more than $30 billion into long/short fundsduring the first nine months of 2006. These funds now sit atop acombined $379.3 billion in assets, more than a quarter of theindustry total. Mashaal garnered a 25.7 percent three-year annualized recordby sussing out beaten-down technology stocks with low price-earningsmultiples, fat cash cushions and attractive prospects. ``We'll buy something that has a 40 trailing P/E, but if welook at where we see it going, it'll have a forward P/E of 10,''Mashaal says. The long/short arena accommodates a variety of investingstyles. Bryant Riley, founder of Los Angeles-based SACC PartnersLP, is an activist whose fund returned 33.3 percent annualizedover three years. ``We take a private equity approach,'' Riley, 39, says. SACCoften demands board seats after building a position in a company.The $118.8 million fund is represented on the boards of 10 ofSACC's 15 core holdings. All of them are microcaps with marketvalues of less than $300 million.
Winning Board Seats
SACC bought shares of Alliance Semiconductor Corp., a Santa Clara,California-based maker of computer memory products, after thecompany's shares had tumbled to less than $1.60 in May 2005. After winning five of seven board seats, Riley and hispartner, John Ahn, ordered management to sell off Alliance'soperating businesses and concentrate on a portfolio ofinvestments it owns. Alliance shares rose to $3.65 on Nov. 8. Its success is such that the fund is changing its name toRiley Investment Partners LP, which will put an end to peopleconfusing the fund with Stamford, Connecticut-based SAC CapitalAdvisors LLC, which was founded by legendary trader Steven Cohen. ``He's unfairly capitalizing on the reputation we've beenbuilding,'' Ahn jokes. ``It's hard to make a buck.'' That's how Donald Brownstein,founder of Stamford, Connecticut-based Structured PortfolioManagement LLC, sums up life these days for hedge funds focusingon the global bond market. Bond funds posted an average annualized return of 7.8percent during the three years ended on Sept. 30, according toHFR. During the first nine months of 2006, they were up 5.9percent.
Fed Headache
The U.S. Federal Reserve has been a big headache for bondinvestors. Since 2004, the Fed has pushed overnight interest rateshigher in an effort to head off a new surge in inflation. It leftthe benchmark federal funds rate unchanged at 5.25 percent on Oct.25. As the funds rate has climbed, so have U.S. Treasury yields.Two-year Treasury yields reached 4.75 percent on Nov. 8, up from3.07 percent in late 2004. Ten-year yields have climbed less, to4.64 percent from 4.22 percent. As a result, investors who borrowat short-term rates to buy bonds make less money on theirinvestments. ``There's been a significant inversion between the overnightrate and the 10-year note,'' Brownstein says. ``It's very hard tomake money in that kind of environment. It's hard for banks. It'shard for everybody.'' Bond managers who focus on mortgage-backed securities haveoutdone many of their peers. Brownstein's $476 million StructuredServicing Holdings LP fund, which specializes in these securities,posted an 8.7 percent average return in the three years ended onSept. 30.
Housing Market
Mortgage bonds are getting riskier now that U.S. home priceshave begun to decline. Banks fashion these securities out ofmortgages and home equity loans. If enough people default on theloans, the securities' credit ratings could suffer. ``The key trend is navigating this slowdown in housing andfinding good opportunities,'' says Tony Lembke, portfolio manager atNew York-based MKP Capital Management LLC. The firm's MKP CreditLP fund, which invests in residential-mortgage-backed securities,posted an average annualized return of 11.7 percent over thethree years. Mortgage Opportunity Fund VI and the Galena Street Fund,both managed by Denver-based Braddock Financial Corp., led fixed-income hedge funds during the three years, according to HFR.Mortgage Opportunity logged an annualized return of 22.2 percentduring that period; it was up 15.4 percent during the first ninemonths of 2006. Galena, which specializes in mortgage-backedsecurities, posted an average annualized return of 15.2 percentover three years and was up 7.1 percent in 2006 through Sept. 30.
The Globalists
What a comedown. The old masters of the hedge fund universe-- macro funds -- can't even beat the S&P 500 Index these days. Macro funds, which trade just about anything, anywhere,posted an average annualized return of 6.7 percent during thethree years ended on Sept. 30, according to HFR. During the firstnine months of 2006, these funds gained 3.2 percent -- less thanthe S&P 500, which rose 7 percent. World markets have been too calm for many macro managers,who tend to thrive on volatility. ``The glory days of macro are over,'' says Paul DeRosa, aprincipal at Princeton, New Jersey-based Mount Lucas ManagementCorp. DeRosa's Peak Partners LP, which posted an annualized three-year return of 13.4 percent, has managed to call recent turningpoints in the markets. The S&P 500 rose 5 percent during the firstfour months of 2006, dropped 2.6 percent through July andadvanced 8.5 percent through Nov. 8. Crude oil started 2006 at $61a barrel, rose to $78 in July and then retreated to $60.
Commodities Play
``We had a good chance in commodities with the run-up inspring and the run-down after July,'' DeRosa says. ``And therewas a chance to catch the rebound in equities.'' James Passin, who manages Firebird Global Fund LP, did evenbetter. Firebird led macro funds in the three years ended onSept. 30, with a 43.6 percent annualized return for its U.S.fund, according to HFR. ``Our theme for the last three years has been naturalresources and the rise of commodities,'' Passin says. New York-based Firebird has been trading everything fromuranium stocks to gold. It's invested in companies with oil or gasconcessions in Africa, Iraq and North Korea, and Passin hastraveled to Papua New Guinea to check oil assets there. One pick, Calgary-based Heritage Oil Corp., wants to pump oilin Lake Albert, between Uganda and the Democratic Republic of theCongo. Another, South Korea-based Finetec Corp., makes cryogenicinsulation used in liquefied natural gas tankers. As investors crowded into commodity trades in 2006, Passinpulled back and loaded up on Japanese construction and technologystocks. Now that North Korea has nuclear weapons, Japan is likelyto embark on a military buildup that will spur industry and theeconomy, he says. Japanese stocks, among them Tokyo-basedMitsubishi Heavy Industries Ltd., accounted for 15 percent of Passin'sholdings in late October. Only 5 percent of the fund's assetswere in U.S. stocks.

Citadel increased earnings moe than fivefold

Citadel Investment Group LLC, thehedge-fund manager founded by Kenneth Griffin, said earnings by its two largest funds increased more than fivefold on gains fromdebt and energy investments. Net income at Citadel Kensington Global Strategies Fund Ltd.rose to $795.6 million in the first eight months of 2006 from$148.4 million in the year-earlier period, the Chicago-based firmtold investors this week in a prospectus for its first bond sale.The fund, which has $9.5 billion in assets, returned 7 percent inthe third quarter, compared with 3.1 percent a year earlier, whenits corporate-debt and energy bets lost money. ``Citadel hired a significant number of new investmentprofessionals since mid-2005 to strengthen both the global creditand global energy business,'' the Nov. 27 document said. Earningsat its Wellington LLC fund, which has $3.3 billion in assets,rose to $389.1 million from $54.3 million. The 363-page prospectus, a copy of which was obtained byBloomberg News, details the finances of the closely held firm,which oversees almost $13 billion for wealthy investors andinstitutions. Hedge funds, private pools of capital that allowmanagers to participate substantially in their investment gains,oversee $1.3 trillion, more than double what the industry'sassets were five years ago. Institutions such as pension funds and endowments havecontributed about $361 billion to hedge funds, according to anOct. 10 report by Bank of New York Co. and consulting firm Casey,Quirk & Associates LLC in Darien, Connecticut. That amount maytriple by 2010.

Kensington's Returns

Hedge funds have struggled to outperform market indexes as aflood of cash from investors has made it harder to make money.Kensington returned 17 percent this year through Sept. 30,compared with the average 8.8 percent for similar hedge funds,according to Chicago-based Hedge Fund Research Inc. The Standard& Poor's 500 Index, a benchmark for U.S. stocks, returned 8.5percent including dividends. Operating costs at Citadel's two main funds rose 20 percentthis year to $805.1 million, the prospectus said, as the companyhired 320 employees since the beginning of 2004. Performance-based compensation is a ``significant part'' of those costs. Thecompany currently has 1,070 employees, including 656 investmentstaffers. Unlike most hedge funds, investors in Citadel funds pay allexpenses. Their costs rose to 8.75 percent of assets in 2005 from4.66 percent in 2003, the prospectus said. Kensington had netwithdrawals of $657.6 million through Aug. 31. For all of 2005,the fund had net inflows of $61.7 million.

Using Leverage

Hedge funds seek to magnify their gains by using borrowedmoney to increase their bets. Citadel's funds borrowed 7.8 timestheir assets as of Aug. 31. Their investments include corporatedebt, energy, stocks, currencies and government bonds, andreinsurance. JPMorgan Chase & Co., the third-biggest U.S. bank, sold itshalf of Amaranth Advisors LLC's energy trades to Citadel for $725million less than two weeks after taking over the positions.Amaranth, reeling from more than $4.6 billion in losses,transferred its energy investments to JPMorgan and Citadel onSept. 19. Citadel bought JPMorgan's share of the natural-gas,power and oil trades on Sept. 29, Citadel said in its prospectus. Bryan Locke, a spokesman for Chicago-based Citadel, declinedto comment. Griffin, 38, started Citadel in November 1990 with $4.6million, three years after he began trading convertible bonds outof his dorm room at Harvard University. Kensington opened with$5.5 million in 1995.

First for Hedge Fund

Institutional investors and so-called funds of funds make upabout 62 percent of the firm's investment capital as of Sept. 30,according to the prospectus. Citadel principals and employeescontributed about 15 percent. Citadel plans to sell bonds as a means to cut its relianceon financing from Wall Street investment banks. In a first for ahedge fund, the firm may sell $500 million of the notes next week,said a person familiar with the offering. Citadel could raise asmuch as $2 billion over time, according to the prospectus. Citadel in January is scheduled to start Citadel SolutionsLLC, which will handle administrative chores such as settlingtrades and valuing holdings for its own funds and other hedgefunds. Citadel said it expects the move to cut fund expenses.

Oil stocks are signaling that crude prices may rebound to a record in 2007

Nymex IPO
Energy-related IPOs raised $3.7 billion in the U.S. lastyear. Just three years ago, no energy companies went public.
Nymex sold its shares for more than underwriters forecast inits initial share offering, and they still jumped more than 125percent the next day on the New York Stock Exchange.
Oil has rallied for almost five years as fuel needs rose,especially from China, leading to record prices. Oil ended lastweek at about $60 a barrel. Natural gas prices peaked at over $14per million British thermal units in December, up from an averageof $2 during the 1990s.
Energy companies are selling shares to finance new projects,including Reliance Industries Ltd., owner of India'slargest refinery. Reliance sold stock in its Reliance PetroleumLtd. unit earlier this year, raising $601 million forconstruction of a 580,000 barrel-a-day refinery.
Buyers ordered 50 times more shares than were available,according to the underwriters. Reliance Petroleum shares surged42 percent after their first day of trading. They have since lost21 percent.
"Oil companies will continue to do well because there is alot of expansion needed both in exploration and refining,'' saidPraveen Martis, an energy analyst at U.K.-based Wood MackenzieConsultants Ltd. ``The energy story is far from over.''
Good Market
We are in a good oil and gas market and investors aretrying to take advantage of that,'' said David Frischkorn, amanaging partner at Dahlman Rose & Co., a New York-basedbrokerage that specializes in energy and shipping. ``Cash flowshave been very, very good and will continue to be good.''
Investors shouldn't mistake a good IPO performance forunderlying strength in an equity, said T. Rowe Price Group Inc.energy analyst Tim Parker, whose firm bought Nymex shares.
"It's more a function of investor enthusiasm thanfundamental strength,'' he said in a Nov. 21 interview.
Parker says oil prices will stay around today's level forabout a year and then begin to rise. He expects Russia and othercountries outside of OPEC to add 1.5 million barrels of crude oilproduction capacity next year, helping to meet ever-risingdemand.
By the end of next year, $60 crude will ``feel more like afloor than a ceiling,'' he said. ``It'll be difficult for non-OPEC supply to consistently meet demand growth.''
The increase in energy IPOs reflect confidence that enoughoil and gas can be found to exploit today's high prices, saidDaniel Yergin, chairman of energy consulting firm CambridgeEnergy Research Associates and author of ``The Prize,'' thePulitzer prize-winning history of the oil industry.
"This is a growth period as the industry rebounds from thecontraction it went through five or six years ago,'' he said.

Bernanke's Programs May Dilute Greenspan's Intuitions

Inside the U.S. Federal Reserveheadquarters, a small team is testing a forecasting program thatdoes the work of hundreds of economists. Never before has the Fedbeen able to crunch in real time such a large mountain of data --as many as 150 indicators -- to divine where the economy isheaded. Chairman Ben S. Bernanke is pushing the ``factor model''program -- so named because it reduces everything from home salesto mining capacity into a few weighted averages for makingpredictions. The Fed could use the help: Its gross domesticproduct forecasts, which influence its interest rate decisions,have missed the mark by an average of 1 percentage point since2000. ``It's a powerful tool that can potentially improve theFed's forecasts,'' says Richard Clarida, a global strategicadviser at Pacific Investment Management Co. and ColumbiaUniversity economist who developed a factor model as an assistantTreasury secretary in 2001. ``Forecasting, especially in realtime, is a challenge, and these programs are not swayed by theemotions or the conventional wisdom of the moment.'' Bernanke called the models ``especially promising'' in aspeech in 2004. He should know. In 2000, as an economist atPrinceton University, Bernanke created one that examined 78economic indicators. He found that its short-term inflation andunemployment predictions were about as accurate as those producedby some 200 economists at the Fed, according to his publishedpaper.

Human Superiority

``That was widely regarded as a successful piece ofempirical work,'' says Princeton economist Mark Watson, a pioneerin the field. Bernanke, 52, also found that computers have their limits.As part of his research at Princeton, he ran a program to seewhat would have happened if a computer had set monetary policyfrom 1987 to '98. Forecasts from Bernanke's factor model were fed into theprogram, which adjusted rates based on certain rules. The result:Inflation and unemployment fluctuated by larger amounts than inreal life, proof that Fed officials are better than software atmaking calls on interest rates. ``We find this evidence for human superiority comforting,''Bernanke wrote. Columbia professor Edmund Phelps, winner of the 2006 NobelMemorial Prize in Economic Sciences, agrees. ``There's going tobe a huge element of uncertainty left that is not captured by thecomputer models,'' Phelps says. ``Now is a time when therehappens to be an unusual amount of uncertainty.''

Betting Against Recession

In February 2006, when Bernanke became Fed chairman, theeconomy was speeding ahead, expanding at a 5.6 percent annualpace, and inflation was holding steady. He gained credibility byhalting the two-year run of interest rate hikes in August asgrowth started to slow. Now, he faces a more daunting set offacts: A plummeting housing market has raised the specter of arecession while inflation has nudged up. Economists aren't providing much clarity. Their predictionsfor 2007 are sharply divided compared with their earlier callsfor 2006. JPMorgan Chase & Co. argues that inflation will spurbenchmark rate increases up to 6 percent. Goldman Sachs GroupInc., taking the opposite position, sees the distinct possibilityof a recession and rate cuts to 4 percent. According to themedian forecast of economists in an October-November BloombergNews survey, officials will lower rates by half a percentagepoint to 4.75 percent in 2007.

Worst Over?

The Fed is betting against a recession even after theeconomy expanded at an estimated pace of 1.6 percent in the thirdquarter. The central bank has held its rate at 5.25 percent sinceJune, hoping that growth is slowing just enough to bringinflation down to about 2 percent or lower. The drop in crude oil prices from July's peak of $78.40 abarrel and higher stock prices may provide a cushion for theeconomy, says former Fed Governor Laurence Meyer, now vicechairman of St. Louis-based Macroeconomic Advisers LLC. ``Theworst may be behind us,'' concurs New York-based Neal Soss, chiefeconomist at Credit Suisse Group. ``Consumer outlays have beenvery strong.'' Housing is a dark cloud in the calculations of othereconomists. Goldman Sachs says a recession is increasingly likelybecause this housing slump is worse than the last two, in 1995and 1998-2000. New single-family home sales fell 23 percent inthe third quarter, and the housing market has yet to hit bottom,says David Rosenberg, chief North America economist at MerrillLynch & Co. ``The chance of a recession is a coin flip rightnow,'' Rosenberg says.

Hard Time

The Fed isn't any better at GDP predictions than privateeconomists, though it does outperform them on inflation,according to research by the Federal Reserve Bank of St. Louis.``Economists have a hard time forecasting turning points,'' Fedeconomist William Gavin says. Factor models, which run on a basic desktop computer, mayhelp officials with those twists and turns in GDP, inflation andemployment. ``It makes it easier to see margins on which we couldimprove our reading on the ongoing state of the economy,'' saysJeffrey Fuhrer, research director at the Federal Reserve Bank ofBoston. The models emulate in a way how Bernanke's predecessor, AlanGreenspan, discerned economic trends from reams of data, saysPrinceton's Watson. ``Greenspan was someone who had greatintuition and understanding about the economy,'' Watson says. The central bank won't say when its factor model will beused to help set policy. For now, Bernanke will have to rely onhis old tool kit to try to avert runaway inflation or recession-- whatever the case may be.

Goldman warns!

The risks for the Turkish Lira appear very skewed to the downside at current exchange rate levels. This doesn't mean we expect a mini-crisis like in Spring, but the potential for some TRY depreciation now appears larger than the carry gains on a tactical trade.
The general environment for EM assets appears to offer limited upside given current valuations. As Mike Buchanan and Salman Ahmed pointed out in their Global Daily this morning, a moderate deterioration in the US and global growth outlook could make current EM valuations look stretched. Yesterday's release of the latest reading of our Global Leading Indicator also points to further slowing in global growth momentum. Most recent data releases from around the globe confirm the idea of gradual slowing cyclical momentum. Most EM assets have ceased to strengthen since the middle of the week, while country specific factors have led to some weakness as in the case of Mexico (falling oil prices).
On the domestic front, Turkey continues to be exposed to significant tension in the external accounts. While the current account continues to deteriorate (our latest estimate for 2006 is 8.3% of GDP), strong speculative inflows have - so far - helped finance the deficit. These have been attracted partly by high local rates and the generally favourable environment for carry trades recently. However, our Yield Outperformance Slice indicates that carry trading has become less profitable recently with zero total returns since late October. Deteriorating performance of global carry trades could make it considerably more difficult to finance the Turkish the current account deficit. It is also worth pointing out that the TRY remains substantially overvalued according to GSDEER, and therefore any attempts to correct external imbalances through slowing domestic demand will remain an uphill struggle for the Central Bank. It may well be related to this factor that the Central Bank on Monday started again to buy foreign currency in daily operations against the TRY (up to $900mn per month) - another factor limiting the upside potential for the TRY from current levels. On the other hand, it is clear the TRY would have to weaken substantially before the CBRT would intervene to support the Lira.
Finally, there remain questions about the political outlook. The EU's Cyprus decision is due next month. And significant uncertainty and risk still surrounds next year's general elections and the question of who will become the next President.
Overall we think the downside for a long EUR/TRY trade is limited at these levels and it makes sense to pay the carry with most factors suggesting more weakness in the not-so-distant future.
Go long $/TRY with a 1-day stop on a close below 1.4300.

Julian Barrowcliffe's AnglianCommodities Fund exited the natural gas market almost a year before Amaranth Advisors LLC

Julian Barrowcliffe's AnglianCommodities Fund exited the natural gas market almost a yearbefore Amaranth Advisors LLC, another hedge fund, was destroyedby plunging energy prices. Barrowcliffe steered his $497 million fund, operated byVegaPlus Capital Partners Ltd., to metals. That helped produce a22 percent gain in the 12 months through October, according to aletter sent to investors in the New York-based fund. The GoldmanSachs Commodity Index has lost 14 percent over the same period. Like Amaranth, whose demise cost investors $6.5 billionafter a bad bet on differences in natural gas prices, Anglianinvests using a so-called relative value strategy. It attempts toprofit from price discrepancies between commodities, markets,delivery dates and locations. ``We decided natural gas was rather hot to handle,''Barrowcliffe, 44, said in an interview from the London offices ofVegaPlus. ``It seemed to us that there was a huge amount of moneychasing returns in the North American natural gas and power spaceand everyone was tripping over each other.'' Demand for commodities from China, where the economy hasexpanded 10 percent in each of the past five years, has helpedfuel prices for oil and raw materials, giving investors such asBarrowcliffe opportunities to exploit price differences. Metals have been the best commodity performers this year.Nickel and zinc have more than doubled while copper gained 55percent because of production shortages and worker strikes. ``The price moves clearly helped to create the anomaliesthat we were targeting to exploit,'' Barrowcliffe said.

Booms and Busts

No matter how a fund chooses to balance its commodityholdings, using a relative value approach is never risk-free,said Matthew Evans, who advises companies on commodity-riskmanagement at NERA Economic Consulting in New York. ``History tells us that commodity markets, particularlyenergy, are cyclical and prone to booms and busts,'' Evans said.``We have seen that price relationships can blow up, very quicklyand very decisively.'' Barrowcliffe so far is beating his declining benchmark indexwith consistency during some of the toughest times forcommodities investors. Anglian gained 11 percent in the third quarter, during aperiod when the Goldman Sachs Commodity index of 24 commoditieslost investors almost 16 percent. In September, as Amaranthcollapsed, Anglian returned 3.1 percent, according to the fund'sinvestor updates, compared with an 11 percent drop for theGoldman index.

Futures

Hedge funds, which manage $1.3 trillion worldwide, areloosely regulated pools catering to wealthy investors andinstitutions, and invest in a range of assets to profit whethermarkets rise or fall. About 8,000 hedge funds trade globally,based on estimates from Hedge Fund Research Inc. in Chicago. Like most hedge funds, VegaPlus doesn't disclose detailsabout the weight of various holdings in its funds. The Anglianfund, which has increased 8.7 percent this year, instead tellsits investors how each holding has affected returns. Metals holdings have returned 16 percent a year sinceAnglian was founded in 2004. Reducing power and gas holdingshelped the fund mitigate annual losses in those commodities to 5percent, according to reports to investors. Natural gas has beenthe worst-performing commodity this year, plunging 60 percent asinventories rose. Anglian also buys and sells commodity futures ranging fromgold to cattle by using computers to help decide when to investabout 25 percent of the fund. Futures are contracts to buy orsell a commodity on a specific date at a preset price.

Price Discrepancies

The fund invests up to 15 percent of its capital in energy,mining and shipping companies, as well as utilities, according tothe marketing documents. As many as 24 out of 100 commodity hedge funds followrelative value strategies, according to Rian Akey, chiefoperating officer of Chicago-based Cole Partners LLC, whichinvests in commodity funds. The remainder uses a mixture of thatstrategy and so-called directional trading, which involvesbetting on prices rising or falling, he said. Spotting relative value differences is Anglian's advantageover traders of so-called physical commodities, who are better atanticipating price movements, Barrowcliffe said. The strategyinvolves trading on price discrepancies, for example, betweencrude oils in different markets, such as West Texas Intermediate-- the U.S. benchmark -- and Brent in the North Sea.

Looking for Wrinkles

``We look for wrinkles in the markets,'' he said. ``I amtrading against guys with storage terminals, tankers, refineriesand who have government relationships. I had to find somethingthat they didn't do. I try to find ways of trading that didn'tfocus on day-to-day price moves.'' Barrowcliffe himself started out in 1985 as a crude oiltrader at Shell International Trading Co. and later headed globalenergy-trading desks at Merrill Lynch & Co. and Bank of AmericaCorp. Born in Peterborough, U.K., he graduated from LoughboroughUniversity with a bachelor's degree in business administrationand French. The Anglian hedge fund, named to refer to ``old England,''was started by Barrowcliffe with money from Madrid-based VegaAsset Management LLC. Vega Asset Management then spun offVegaPlus, which has $2.5 billion in assets, including the Anglianfund. Vega Asset Management also runs Vega Select Opportunities, ahedge fund whose investors sought to pull about $400 millionafter it fell almost 11 percent in September. Vega AssetManagement's capital now accounts for only 2 percent of theAnglian fund, according to an investor letter.

Shifting Risk

Barrowcliffe operates from what he describes as a ``roomwith a bunch of screens and money,'' in contrast to physicalcommodities traders who get access to information on underlyingassets such as shipments or refineries before other traders. Hisfive-person team includes Uday Narang, previously Europeanpresident of Entergy-Koch LP, and Toly Spheeris, who co-foundedGreenwich Energy Partners in 2002. Shifts in Anglian's portfolio are indicated by the fund'sreports on value at risk, or VAR, which investors use to measurethe potential a company or fund may lose on a given day. Formetals, the fund's VAR rose to 0.35 percent from 0.09 percent,according to a letter sent to investors. The fund's VAR innatural gas was cut to zero from 2.3 percent in the past year. Funds that were less prescient paid the price. The plunge ingas prices also led to the closure of MotherRock LP, a $400million New York-based hedge fund, in August. While Barrowcliffedeclined to comment on failed funds such as MotherRock orAmaranth, he said that having a nose for gas trends has so farvindicated his strategy. ``You had a lot of people throwing lots of money at naturalgas, drawn to the volatility,'' he said. ``There's volatility andchaos and there's a fine line between the two and if the marketis teetering on the brink of chaos you might not want to bearound for it.''

Beyond the French « No » vote…

The European Union’s Nice Treaty was widely perceived as a disappointment in terms of bringing much needed progress on reform and innovation ahead of the challenges of enlargement. The new Constitution proposed significant improvements on these issues with main points of interest for the markets being improving the flexibility of decision making in the enlarged Union delegating power from national governments towards the Union.

A French "No" vote to the Constitution would jeopardise these achievements. The strength of opposition in opinion polls has taken France by surprise. Over the past two weeks, however, it seems that the "Yes" camp is adopting a more aggressive strategy. All members from the main French parties, including the UMP and the Socialists, have been mobilized. The next two weeks will be key to determine how the odds are turning.

So far it appears that there is no clear plan B in case of a "No" vote from France. Indications are that the ratification process in other member states would continue. Therefore, the capacity of manoeuvre for France in any future renegotiation process will be linked to the prospects of other member states also joining the "No" camp.

I am doubtful that the EUR will suffer significantly versus the USD. The "No" vote should not be interpreted as a political mandate from the electorate to destroy euro-zone. Also, the lack of improvement in US twin deficits limits the capacity for the USD to establish a structural positive trend against the EUR.

In my view, the impact is more likely to be felt on the periphery of the Union, namely on Turkey, where the risk of a setback in the EU accession process could prompt capital flight after last year’s heavy inflows, against a backdrop of a declining carry attraction of the TRY and a wide current account deficit. The currencies of some new EU members, especially PLN and HUF, are also at risk from a setback in financial convergence expectations, as the lack of political
visibility in the Union could weaken the political commitment to speed up public finance reforms in the next couple of years. The near-term political agenda in Poland and the persistent twin deficits in Hungary would reinforce the negative impact on currencies.

Bond yield conundrum is back

The conundrum is back. Just two months ago, with US Treasury 10-year bond yields hovering around 4 per cent, Federal Reserve chairman Alan Greenspan wondered publicly why they were not higher. Investors took the hint and pushed yields rapidly up to 4.6 per cent. But the recent burst of risk aversion in the financial markets has sent 10-year yields back down again to 4.25 per cent.


Traditionally, bond yields have tended to rise during periods when the Fed is tightening monetary policy. However, 10-year yields are lower than when the Fed first raised rates in June 2004. The recent batch of weak economic data provides the rationale for the latest shift in yields. Treasury bonds have gained from their "safe haven" status at a time when investor sentiment seems suddenly to have deteriorated.

According to State Street, institutional investor confidence posted its biggest fall for 10 months in April; the poll was taken before last week's equity sell-off. The German ZEW survey of investor confidence, announced on Tuesday, fell more sharply than expected. The American Association of Individual Investors says that bullish investor sentiment has plunged to 16 per cent, its lowest level since September 1992.

All this must be a great disappointment to those pundits who predicted 10-year Treasury bond yields would hit 5 per cent by the end of this year. And it suggests that, for the moment at least, investors are ignoring two factors many believed would prove negative for bonds.
The first is that the US's heavy need for financing, thanks to its trade deficit, would eventually lead bondholders to demand higher yields. While the deficit is still getting wide, capital flows data indicate no shortage of future buyers.

The second factor is the threat of higher inflation. US producer prices rose 4.9 per cent in March while the most recent consumer inflation numbers showed a 3 per cent annual increase. But price pressures are much more subdued at the core level, which excludes volatile elements such as food and energy.

The lurking threat is stagflation, slower growth and higher prices. But the recent bond rally indicates that investors are not yet convinced this threat will materialise.

Phantom of the Street

Capital Markets
Who is the bidder at 10 year treasuries? thats the question even mighty Greenie is asking. We are going to see an inverted curve very soon. Which is not a good sign for the future of the economy and a strong indicator of deflation pressures. FED is a bit behind the curve and if it can not solve the "conondrum" soon, it gonna face the inevitable: the deflation. After 3 years of abnormally low interest rates FED will be in a position whose futile efforts do nothing but delay the inevitible 3 years and created another buble on the housing. Mighty Greenie failed this time.

Ready to go full pelt on Turkish Assets?

I have never been so bullish on Turkish assets before. Turkey is the best play in emerging markets sector with its momentum, and convergence play.