December 16, 2017

Hedge Funds Need an Oil Change

Future hedge fund manager?

"We just moved into town. My father bought the oil refinery." "That explains why you're so refined!" "Yeah, and so oily!"

Today’s Wall Street Journal says hedge funds need an oil change. Some of the best and the brightest got caught up in the trade going the wrong way on them. CHRISTIAN BERTHELSEN, JULIET CHUNG and HARRIET AGNEW write:

A wrong-way bet on global oil prices has hit some of the crude market’s most high-profile investment firms, including hedge funds run by former Goldman Sachs traders, worsening what has been a dismal year for commodity-fund returns.

Wagers that the gap between Brent and West Texas Intermediate crude-oil prices would narrow were upended when the “spread” between these two prices instead diverged during September and October.

Andurand Capital Management LLP, a $315 million fund run by former Goldman Sachs and Vitol oil trader Pierre Andurand, got caught when the gap widened. The fund posted a 5.8% loss last month. Saugatuck Energy told investors it was down 13% in October because of the spread trade.

Several funds that suffered in October are still in the black year to date, mainly because of the big profits reaped earlier in the year from spread bets.

Frere Hall Capital Management fell by about 20% in October, although it isn’t clear how much of that can be attributed to Brent-WTI bets, according to two people with knowledge of the firm’s preliminary results. The fund, which had $650 million under management in September, was started in July 2012 by Taimur Hassan, who previously had overseen proprietary energy trading at Goldman Sachs.

Astenbeck Capital Management, a $4.1 billion commodity hedge fund run by former Citi energy trader Andrew Hall, also had losses in September and October, according to marketing materials reviewed by The Wall Street Journal. Losses in those months put Brevan Howard Asset Management LLP’s $880 million commodity-strategy fund in the red for the year, according to investors.

“A sharp reversal tends to hurt quite a bit,” said Osvaldo Canavosio, a head of trading strategy with FRM, a Man Group fund that invests in other hedge funds. “It tends to have a pretty significant impact on returns, because people have been positioned in a certain way on something that was working relatively well.” Mr. Canavosio wasn’t referring to the recent performance of specific firms.

slower growth in China and abundant supplies have led to a softening of commodity prices as well as less volatility. As a result, it has become more difficult for commodity hedge funds to find easy profits and keep investors happy. Year to date, the oil-heavy Dow Jones-UBS Commodity Index is down 12%. The S&P 500 is up 26%.

Faced with paltry returns on straightforward bets and struggling to hold on to investors, some energy hedge funds have pursued strategies that sought to capitalize on changes in the price gap between contracts. In betting the spread would converge, traders bought contracts for benchmark U.S. crude while selling those of its global counterpart.

Brent traded at a premium of more than $23 a barrel to WTI crude on the New York Mercantile Exchange in February, but a rise in Nymex prices whittled the gap down to nothing by late summer. U.S. oil prices rose—while Brent prices remained steady—mainly because new pipelines relieved a glut of crude in the Midwest, where Nymex oil is priced.

Many investors and analysts expected prices of the two crude contracts to continue trading close together. But an influx of crude imports and lower oil demand from U.S. refineries sent prices of cash crude in the Gulf Coast falling. In the week ended Oct. 11, imports from Saudi Arabia averaged 1.95 million barrels a day, according to estimates from the Energy Information Administration. That is the fastest rate since January 2012.

The crude glut in the Gulf Coast rippled back to the Midwest, driving the price of WTI sharply lower and causing the spread to widen again, analysts and traders say. The price gap went from 97 cents a barrel on Sept. 18 to $13.33 on Oct. 23.

Despite the hit many funds took, some remain in positive territory for the year. Andurand Capital is up 27% thanks to profitable spread bets placed earlier this year, according to a person familiar with the firm’s performance. Mr. Andurand shuttered energy hedge fund BlueGold Capital Management LLP in 2012 after the fund lost more than 30% in 2011.

But not all funds are faring as well.

Astenbeck Capital’s negative 2.9% return for October brought year-to-date losses in its main fund to 5.1%. That is Astenbeck’s worst performance for that 10-month period since the fund’s 2008 founding. Mr. Hall is best known for his expected $100 million payday in 2009 when he was the head trader at Citigroup’s Phibro energy-trading unit. His compensation ignited a debate about pay practices at banks receiving government support. Citigroup agreed to sell Phibro in late 2009 so it didn’t pay him for that year.

Amaranth Capital was a hedge fund that blew up quickly from a wrong-way bet on commodities. Hedge funds should do what their name implies and hedge their exposure. At the very least, some hedge funds need an oil change.

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