The legacy of Amaranth

"With some of the really huge hedge fund of funds, they had so much capital to put to work that it was a fait accompli that they would invest in Amaranth, because of its size," said Bruce H. Lipnick, chairman and chief executive officer of Asset Alliance Corp., New York. Asset Alliance manages about $500 million in hedge funds of funds and did not invest in Amaranth. "And when you use 50 or 60 managers in your portfolio, it was really hard to miss Amaranth," Mr. Lipnick said.

Other large funds making Amaranth-related changes include the board of the $46 billion Massachusetts Pension Reserves Investment Management, which tightened its investment guidelines rather than replace its hedge fund-of-funds managers, said Michael Travaglini, executive director.

"Did you invest in Amaranth?" is the very first question being asked in meetings with institutional investors and their consultants, said one hedge fund-of-funds executive who requested anonymity. The source's firm did not invest in Amaranth, but he noted that for funds of funds that did, "How believable their argument is about why they were in Amaranth at all depends to a great extent on how big their exposure was."

That's one of the first questions investment officials at the New Jersey Division of Investment asked when it started investigating what happened at Amaranth and what exposure the fund had through its funds of funds.

According to Mr. Clark's analysis, the New Jersey fund had $22 million invested in Amaranth through three funds of funds. Arden's allocation to Amaranth was 7.78% of the commingled hedge fund of funds in which the state invested. That's more than twice the exposure of New Jersey's two other hedge funds of funds that invested in Amaranth: 3.6% by Goldman Sachs and 3.3% by Rock Creek Management. Both firms manage separate accounts for the New Jersey fund that mimic the portfolios of their commingled funds, Mr. Clark said in his memorandum. Arden manages a $100 million mandate for the New Jersey fund; Goldman Sachs manages a $250 million portfolio; and Rock Creek manages $150 million.

Rather than terminate its hedge fund-of-funds managers, Mr. Clark's memorandum recommended several changes that have been incorporated into the New Jersey's investment process. Those changes include:

cchanging the fund's formal policies for alternative investments to require better due diligence and risk monitoring from fund-of-funds managers;

• greater emphasis on transparency and/or liquidity in structuring direct hedge fund investments;

• more frequent interaction with hedge fund managers by several senior investment professionals (a combination of staff and external consultants). Optimally, at least one of these professionals should not have a personal relationship with the managers;

• changing the 2007 investment plan to give as much of 50% of the total hedge fund portfolio to hedge funds of funds; and

• making larger direct investments with hedge fund managers willing to provide transparency and liquidity, and focusing on smaller managers (with less than $1 billion under management).

Mr. Clark's memorandum to his trustees provided New Jersey trustees with an in-depth look at entire Amaranth situation, why the plan's hedge fund-of-funds managers invested in Amaranth and how the managers handled its demise.

The memorandum is available on Pensions & Investments' website at www.pionline.com.

As for MassPRIM, the Boston-based fund has invested $4.6 billion in hedge funds and fund of funds, including $475 million with Ivy and $405 million with Rock Creek. Ivy had a $34 million exposure to Amaranth, and Rock Creek, $22.5 million.

Following the Amaranth debacle, the plan reduced its exposure to any single hedge fund manager within a fund of funds to 8% from 20%; reduced the proportion of any hedge fund manager's total assets that PRIM's investment could represent to 7% from 30%; and tightened leverage. Mr. Travaglini also said PRIM now insists its hedge fund-of-funds managers be more proactive in their communications about the underlying hedge fund managers in their portfolios.

Mr. Travaglini said "hedge funds of funds pushed back on our suggestion that they require 100% transparency from underlying hedge fund managers. They convinced us that they will eliminate a number of good managers with this requirement and that they don't need to know exact position-level holdings of their managers. Instead, they need to know the risk profile of those managers' portfolios and how that fits into the overall fund-of-funds portfolio."

The $4.6 billion Philadelphia Employees Retirement System also had exposure to Amaranth through hedge fund-of-funds investments. Arden manages $50 million for the plan; Rock Creek manages $5 million; New Market manages $3 million; and Allianz Hedge Fund Managers manages $30 million. CIO Christopher McDonough said trustees have been asking a lot of questions and, while no manager or hedge fund policy changes are planned at the moment, adjustments could be made later.