Hedge Hogs: The Cowboy Traders Behind Wall Street's Largest Hedge Fund Disaster
The only book-length account of Brian Hunter's gas book.
Summary
Dreyfuss, an investigative journalist, wrote about the collapse of Amaranth Advisors, which lost roughly six billion dollars in natural gas positions in September 2006, at the time the largest hedge fund loss on record.
The mechanism is the substance. Brian Hunter, a trader in his early thirties, ran the fund's natural gas book from Calgary. His positions were calendar spreads, meaning long contracts for one delivery month against short contracts for another, principally betting that winter prices would rise relative to shoulder months. The positions grew until Amaranth held a very large share of the open interest in specific contract months on the New York Mercantile Exchange, which meant Hunter's own trading was setting the prices at which his positions were marked.
That is the trap the book describes. A position large enough to move a market cannot be exited without moving it against the holder, so the only way to sustain it is to keep adding, which increases the size further. When the price moved against him in September 2006 the fund could not liquidate, faced margin calls it could not meet, and transferred the book to JPMorgan and Citadel at a very large discount.
Dreyfuss also covers the regulatory dimension: Amaranth moved positions from the regulated New York exchange to the InterContinental Exchange, which was then subject to different oversight, when position accountability limits became inconvenient, and the subsequent Commodity Futures Trading Commission and Federal Energy Regulatory Commission proceedings addressed this.
The institutional questions are the ones investors should take. Amaranth had been marketed as a diversified multi-strategy fund and had become a single concentrated natural gas position. The fund's risk management did not constrain the trader who was producing its returns.
The book is journalism with a clear position about the traders it describes. The position sizing and market impact mechanics are accurate and are the transferable content.
Key takeaways 7
- Amaranth held a very large share of open interest in specific natural gas contract months, so its own trading set the marks on its positions.
- A position large enough to move a market cannot be exited without moving it against the holder.
- Sustaining such a position requires adding to it, which increases the size and makes exit harder still.
- A fund marketed as diversified and multi-strategy had become a single concentrated commodity position.
- Risk management did not constrain the trader who was producing the fund's returns, which is the recurring institutional failure.
- Positions were moved to a less regulated venue when position accountability limits became inconvenient.
- The book transferred to buyers at a very large discount, because the buyers knew the seller had no alternative.
Who should read it
Risk managers and allocators who want a case study in position concentration, market impact and the failure of risk functions to constrain profitable traders.
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