By Jason Huemer –
So far, 2004 has been more than a little challenging for hedge fund managers. The markets have lacked a strong fundamental directional underpinning while equity and credit markets have seen a sharp drop in volatility.
Now, however, some industry participants believe they may have found a solution to these travails: energy trading.
Like moths to a flame, hedge fund managers have been drawn to energy this year, attracted by soaring volatility and by rising commodity prices, particularly in the oil markets. As a result, by some estimates there are now more than 100 hedge funds focused on the sector. And anecdotally, there are dozens more on the drawing board as energy traders, sensing growing demand and a fertile market, tee up specialised funds to capitalise on the opportunity.
Of course, hedge fund participation in the energy sector is nothing new. According to trade publication Energy Risk, recent CFTC figures indicate that 68 of the top 100 hedge funds are registered as commodity pool operators, or CPOs, meaning they invest a material portion of their assets in the commodity markets, including energy. Many of these are established players who have been active in trading the energy markets for some time.
In fact, while recent and pronounced, this latest growth spurt for hedge fund energy trading is the second wave of a longer-term trend, one that began with the collapse of the big energy merchants two years ago. As leading energy traders such as Enron, Dynegy, and Aquila wound down, they left a vacuum in energy trading and scattered traders on the market. While UBS picked up the bulk of Enron’s trading operations, much of the best talent ended up in the hedge fund community. D.E. Shaw tapped traders from Aquila to start its successful energy trading businesses and Citadel hired Enron’s highly regarded former quantitative research chief Vincent Kaminski (since defected to Sempra Energy) to head a team of former Aquila traders. Elsewhere, John Arnold, Enron’s 27-year-old whiz-kid star trader, set out to form his own hedge fund, Centaurus Capital.
More recently, however, the hedge fund community has seen an influx of new energy-focused funds and more significantly a number of sizeable multi-strategy players entering the sector. Among the notable recent entrants are Vega Asset Management and Ritchie Capital Management, both of which have funded energy trading ventures this year. Other managers have targeted the business, as demonstrated by the recent auction of assets by Centerpoint Energy, which drew hedge funds Perry Capital, Seneca and Cerberus, alongside active and longstanding energy investor Caxton Associates.
At the same time, a handful of former energy merchant traders have hit the market to form energy-trading funds that in many cases emulate the activities of their former trading desks. Even some operating executives have got into the game, among them former Anadarko Petroleum CEO John Seitz, who founded long-short manager Fischer-Seitz Capital Management.
Data from industry researcher Hedgefund.net show year-to-date returns for the sector of more than 6 per cent and returns for the past 12 months of almost 12 per cent, far outstripping numbers seen from many other strategies. Arnold’s Centaurus fund, is reportedly up 100 per cent year-to-date with a capital base of over $600m.
From the managers’ perspective, the energy markets offer volatility and broadly rising prices in some key sectors such as oil, providing a solid foundation for active managers to ply their trade. More important, energy trading has represented a less crowded playing field with a level of innovation that is spawning new markets and trading opportunities.
The sector has recently seen the creation of new instruments such as storage swaps and spread options, the former of which enables such abstruse trading strategies as synthetic storage for physical trading. While it is difficult to determine precise return drivers for any of the energy traders, it is interesting to note that Arnold’s phenomenally successful fund was on one side of the first storage swap transaction, completed earlier this year.
Of course, as with all hedge fund developments, this trend has attracted more than its share of sceptics and critics. Some claim recent success is unsustainable, driven by rising oil prices. Others blame hedge funds for volatility for driving up the price of oil through rampant speculation. Some have even sought to indict hedge funds for supposed manipulation of natural gas prices during a substantial price spike late in 2003. For their part, hedge funds point to non-directional return sources, strong fundamental underpinning for recent oil price increases and the recent exoneration of natural gas trading by a CFTC investigation.
Most hedge funds put such criticism down to the usual cause: professional jealousy.
Source: Yahoo News