Hedge fund woes and the chemical industry

Financial Events, Leverage, Pension funds

The US Senate thinks the Amaranth hedge fund increased the costs of natural gas futures contracts last year. Any pension funds invested in Bear Stearns’ hedge funds might want to check on the current value of their holdings. Firstly, a US Senate investigation has found that the Amaranth hedge fund influenced prices in the US gas market last summer, and that its speculative trading led to wide swings in gas prices.

Amaranth was the hedge fund which bet heavily last summer on a repeat of 2005’s hurricane season. At its peak, its gas trades were worth $18 billion, and between February – July 2006 it often controlled more than half of the open Nymex futures contracts for November 2006 and January 2007 delivery. Unfortunately for Amaranth, the bet went wrong, and it ended up with losses of $6.6 billion.

3M’s pension fund turned out to be one of the biggest losers, as it had invested about 1 percent of its $9.2billion portfolio in the fund. But the losers were not just Amaranth’s investors. As Senator Carl Levin commented, ‘the victims were gas users who needed to hedge costs by buying futures contracts for the fuel at inflated prices’. For example, the Senate found that the Municipal Gas Authority of Georgia suffered hedging losses of $18 million.

Potentially, therefore, much of the US chemical industry could have been similarly affected. It not only uses gas as a major feedstock for petrochemicals, but also to power many of its manufacturing operations. Although any costs to the bottom line are probably impossible to calculate for individual companies, they may well have been significant.

Secondly, there is the news that Bear Stearns (BS), the leading investment bank, has had to raise $3.2bn to protect one of its hedge funds, whilst it has said it will not rescue another Fund, the Bear Stearns High-Grade Structured Credit Enhanced Leveraged Fund.

Developments with this latter Fund send a chill down my spine, and I fear we may find ourselves returning to this subject in later posts. Apparently it began last August with equity of $40 million from a few senior BS executives, and $600 million from wealthy investment clients. It then took out $7 billion of loans, to make it more than 10 times leveraged.

According to the Financial Times of 29 June, the Fund invested in the US sub-prime mortgage markets, and apparently its $11.5bn of long positions ‘were in bonds and bank loans with AAA or AA credit ratings…which are supposedly safe’. But in spite of this, BS has now said it will not rescue the Fund.

The question in my mind is therefore ‘Who are the ultimate investors in this Fund, and do they know the current value of their holdings?’ If the FT is right, any chemical company pension funds thinking that they own top quality AAA or AA bonds in the BS Enhanced Leverage Fund may be about to discover that their holding is worth much less than face value.


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