Institutional Investor's Alpha Magazine - February 2008 - (Page 29)

by owning futures — but by buying the land itself and marketing the crops directly. Warner is keeping the Full Harvest fund small to start, and has soft-closed at $150 million under management (with an eye to ultimately manage about $300 million), but she is excited about the conﬂuence of trends in agriculture. Like Anderson, she worries about index fund money altering what ought to be fundamental price dynamics in agricultural commodities, but she doesn’t think farmland itself is experiencing a pricing bubble. “You don’t have a one-year bubble,” says Warner, who has already bought land in Kansas, Mississippi and Texas. “We’ve seen areas that may have gotten ahead of themselves, like Iowa and Illinois, but there are many places where we can still ﬁnd good value. I don’t think there is a lot of downside, because for the past 30 years agriculture didn’t participate in the upside of what was happening in the U.S. markets.” The farmland investing trend is now spreading to the U.K. and Europe. In October 2007, New York–based al- ternatives asset management ﬁrm BlackRock launched a London-based agricultural hedge fund to invest in farmland, commodities futures and agriculture-related equities. In the U.K., farmland values have been surging: Prices of all types of arable land rose 28.2 percent last year, to approximately £3,450 ($6,800) an acre, according to the Rural Research division of Savills, a British real estate ﬁrm. THE CURRENT GLOBAL grain drain is enough to give some commodities experts bad dreams. In the spring of 2005, the Central Intelligence Agency invited Pimco’s Greer to Washington to consult with a group of its analysts. The CIA wanted Greer to talk to the team about the possible threats to the U.S. economy from the commodities markets. Everyone was quick to decry U.S. dependence on imported oil, Greer recalls. But he was pleased when one analyst asked him what he most feared outside of the known complexities and dangers of the energy markets. “Drought,” Greer answered. “My worst nightmare is broad hedge fund involvement in energy, however, began after the 2001 collapse of Enron, which prompted many to pull out of the market, creating a vacuum into which hedge funds and some investment banks — including Goldman, Sachs & Co. and Morgan Stanley — rushed. By 2004, Boston-based research company Celent estimated that hedge funds accounted for as much as 21 percent of the open interest on the Nymex. And the funds are not limiting their futures trading to oil, showing interest as well in electricity, heating oil, gasoline and especially natural gas. As the markets have become more electronic, such interest has only increased. Energy futures can be especially volatile, at the mercy of hard-to-calculate variables, particularly weather. Nowhere is this more clear than in natural-gas futures. The history of hedge funds is littered with blowups in natural-gas trading. New York–based fund MotherRock, cofounded by a former Nymex president J. Robert Collins, was one such collapse, caught in short positions in the summer of 2006 after heat waves caused an unusual spike in natural-gas demand and a 50 percent price increase over two weeks. Similarly, Ritchie Capital in Chicago was trapped in short positions in 2005 when Hurricane Katrina struck. Bets on natural-gas futures in the late summer and early fall of 2006 — in anticipation of hurricanes that never arrived — caused $9 billion Greenwich, Connecticut–based Amaranth Advisors to close shop. Centaurus Energy, by contrast, was on the opposite end of the kinds of natural-gas bets Amaranth made, and it proﬁ ted handsomely. Arnold, the fund’s 33-year-old manager, gained fame for his stint trading natural gas at Enron. After the energy company’s collapse, he launched his own hedge fund ﬁrm, which has been so successful — producing 160 percent and 200 percent returns in 2005 and 2006, respectively — that it has returned most of the original investors’ money. Almost all of the ﬁrm’s $3 billion is now Arnold’s own money. Last year — in a sign of the times — Centaurus returned a comparatively paltry 50 percent, its worst performance ever. More activity in energy futures by the energy companies themselves, by long-only investors and by quantitative hedge fund managers like Chicago-based Citadel Investment Group and D.E. Shaw & Co. in New York (which often prefer data-driven trades over fundamentals) has contributed to short-term volatility. Some market participants argue that newcomers to the market have helped divorce the price of futures contracts from the underlying commodities. “Natural gas and crude are driven by supply and demand,” says an industry consultant who worked at Enron. “But because you have so many technical traders among the hedge fund traders, you will have crazy price action.” The new volatility can cause big losses even if an investor’s long-term prognosis proves correct. “Eventually, the fundamentals reassert themselves, but that can take time,” the consultant notes. Shrayer, the Morgan Stanley executive, points out that the markets can only be out of step with reality for a very short time. “Ultimately, you have to pay the piper,” he says. Few hedge funds (Citadel being an exception) are set up to take delivery of the underlying com- modity. But, increasingly, many funds are looking at investing in production, distribution and storage. Centaurus invests in NGS Energy Fund, a Westport, Connecticut, gas-storage ﬁeld company. Of course, there are hurdles to investing in production, distribution and exploration. It requires a global network of knowledgeable contacts and enough in-house expertise to help separate the deals from the duds. Paul Touradji, who founded New York–based commodities specialist hedge fund Touradji Capital Management, emphasizes the importance of both. An investor in energy’s public and private sectors as well as in the futures markets, Touradji has more than $2 billion under management and returned 40 percent on his main fund last year. The fund, according to information provided by investors, had, with leverage, 69 percent of its exposure in commodities, 42 percent in public equities and 8 percent in private ones. His positions included a stake in privately held Madagascar Oil, which has offshore rights in the Indian Ocean. A young analyst, sent to view the company’s operations before the fund invested, was stranded when the helicopter ferrying him over the jungle broke down. He and his companions had to guess the way back to civilization, hiking for almost a day to ﬁnd the nearest village. A survival story can help put the relative safety of the futures pits in perspective. But the pits are not without peril, and no matter what the dangers — and despite the warnings raised by ﬁascoes like Amaranth — there is no sign that managers are pulling out of the energy markets. The potential for profit is simply too great and demand from investors too high. — Imogen Rose-Smith FEBRUARY 2008 • INSTITUTIONAL INVESTOR’S ALPHA • 29

Table of Contents Feed for the Digital Edition of Institutional Investor's Alpha Magazine - February 2008

Institutional Investor's Alpha Magazine - February 2008 Contents Letter from the Editor Longs & Shorts Pension Corner: Alternative Perspective The Good Guys: A Simple Plan Cover Story: Energy and Commodities: Fueling Opportunity Regulation: Energy Trading: The Brawl on the Hill Interview: Master of Values Regulation: Hedge Fund Registration: Way Out West Research Center: Top Hedge Fund Analysts Alpha Bytes: Rocket Man Unhedged: Commentary: Structured for Success

Institutional Investor's Alpha Magazine - February 2008

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