Amaranth managed to trample the most revered investing
principles
DEREK DECLOET
22:28 EDT Saturday, Sep 23, 2006
Technically speaking, the firm Nick Maounis founded, Amaranth Advisors, is an investment
shop. Or at least it was, until he decided it was a good idea to hand control of most of its assets to
a trading group led by a 32-year-old, Ferrari-driving kid named Brian Hunter. Now the firm is a
smoking hulk and a black mark on the otherwise-blossoming hedge fund industry. Imagine a
company the size of Canadian Tire disappearing in a week, and you have some idea of the
wealth that has vanished: about $6-billion (U.S.).
What would Ben say? That's Ben as in Benjamin Graham, the man considered the intellectual
father of modern investment analysis. This week marked the 30th anniversary of his death,
though it's doubtful many on Wall Street noticed, engrossed as they were in watching the carnage
in Connecticut. Three decades on, his work is still influential -- Warren Buffett called Mr.
Graham's The Intelligent Investor "by far the best book about investing ever written."
Read Mr. Graham, and you can learn a lot about why Amaranth lost, and how you can win. One
of the man's pet peeves was the way people confused investing and speculating, when he saw a
world of difference between the two. "In the easy language of Wall Street, everyone who buys or
sells a security has become an investor, regardless of what he buys, or for what purpose, or at
what price, or whether for cash or on margin."
Investing, in Mr. Graham's mind, meant doing a proper analysis on an asset's true worth, then
trying to buy it at a large discount. Period. True investors were not gunslingers. They went for
"safety of principal and an adequate return." They looked for lopsided bets -- securities where the
potential losses were, say, 10 per cent, but the possible gains much larger. They didn't try to
predict price moves. They certainly didn't buy natural gas derivatives in the hope that a Category
4 hurricane would blast through the Gulf of Mexico. Mr. Graham probably had no idea what a
natural gas derivative was.
He didn't think that sort of gambling was immoral, though. "Speculation is always fascinating, and
it can be a lot of fun while you are ahead of the game," Mr. Graham wrote. The key is to avoid
what he called "unintelligent" speculation: "speculating seriously" instead of as a pastime; "risking
more . . . than you can afford to lose"; "investing with borrowed money." Amaranth went three-forthree. The hedge fund's partners may also have had a sense of infallibility -- something Mr.
Graham maintained was another defining characteristic of the speculator. He wrote: "Each one
has the feeling . . . that his skill is superior to the crowd's . . . But such claims are unconvincing."
Even so, he recognized there can be long periods where speculators rule and appear to be the
smartest people in the market. We've just come through such a spell, though as each week
passes, it seems more obvious that it's over.
The TSX, with dozens of stocks that don't come close to meeting Mr. Graham's criteria, slid to its
third consecutive weekly loss for the first time since the Red October of 2005. Guess who's
leading the slide? The speculatives. We're speaking of companies like Tanzanian Royalty
Exploration, which, as the name suggests, is a mining play (gold, in this instance) in Tanzania. It
may have fine prospects; what it doesn't have are revenue, dividends or shareholders' equity, but
that didn't stop it from acquiring a market value of nearly $850-million (Canadian) by this April. Mr.
Graham would disapprove.
Then the froth started to come out of the market, and it has plunged 41 per cent since. Mind you,
it's got plenty of company. First Calgary Petroleums, Sino-Forest and others have all sold off
sharply. The TSX Venture Exchange, a motley crew of speculative has-beens and never-will-bes,
has declined 25 per cent since its April peak. The winners have been Graham-style blue chips,
dividend payers, and firms with reliable earnings.
Amaranth's demise, really, is just an illustration of a market trend that has been building for
months: The speculators are in retreat. Real investors are taking over. Mr. Graham's principles
will never go out of style -- he'll be just as famous 30 years from now as he is today. We doubt
the same can be said for Brian Hunter or Nick Maounis.
ddecloet@globeandmail.com