Amaranth Hedge Fund Blowup

As an investor, do you know how can you avoid the next Amaranth? As more and more individuals are investing directly in the hedge funds, it is essential to calculate risks since the Securities and Exchange Commission (SEC) offers slight oversight. Recently, a federal appeals court cancelled the SEC’s right to register funds and check their books.

It is not hidden now that Amaranth Advisors lost $6 billion in a wrong bet on natural-gas prices in September. The impact of that trading disaster goes far beyond the industry. For example, the San Diego County pension fund is reported to have invested $175 million in the fund and lost an estimated $45 million.

The industry’s opacity has often upset regulators and big investors. Even private watchdogs have failed to spot the next wreck. There are a lot of dark corners to the industry, yet how to spot a risky portfolio, before it is too late? Here are some things to do and questions to ask before investing in hedge funds.

First, search for a due-diligence consultant. If independent, they will be able to dip into offering statements and other documents to identify potential problem areas. Some consultants have modeling software that can show you the weak areas of a particular portfolio. However, even with software, the complexity of some funds makes it hard to spot trouble areas. Evaluate liquidity, credit, and market risks. Try to find the answers to these questions. How much leverage is the portfolio using? Do the funds you’re considering have highly illiquid or hard-to-value investments? Can you get your money out in a short time? Many funds set the condition of an initial ‘lock-up’ period that prevents easy redemption.

Predicting the next hedge-fund blowup is similar to forecasting the next devastating hurricane. You cannot predict when it will occur, but you may know where storms are likely to hit. Although, it is a matter of probabilities, it helps extremely if someone can give you some odds.