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MotherRock - Natural Gas

2006-08

Count of distinct funds: 1

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stories: bloomberg.com, thestreet.com, thestreet.com, epochtimes.com, google.com, cnn.com, itulip.com

MotherRock, a hedge fund founded by former NYMEX President Robert Collins, made a bad bet on natural gas and lost nearly a half a billion of investor money. Per Bloomberg:

"We are in the process of developing a detailed plan for winding down the fund," Collins said in a letter sent today to investors in his MotherRock Energy Master Fund. MotherRock, begun in December 2004, invests in gas futures, seeking to exploit price differences based on the delivery month for the contracts. ...

MotherRock had "significant losses" in July, though a final tally is not yet available, Collins said in the letter, obtained by Bloomberg News. The timing of the shutdown has not been established, according to the letter.

In the first half of this year, MotherRock lost more than 23 percent, with most of the damage coming in June. The fund returned 20 percent to investors net of fees last year.

MotherRock had more than $400 million in customer funds earlier this year. ...

"There is a pretty high rate of mortality among hedge funds," Pirrong said. "When things are good they are very good, but when they're bad they're awful."

Indeed. Regarding MotherRock's beginnings, TheStreet reported:

MotherRock, which was formed in December 2004, opened for business in 2005. Collins founded the fund with John D'Agostino, a former Nymex executive, and former Nymex trader Conrad Goerl. Carol Coale, a former Prudential Equity natural gas analyst, headed up MotherRock's research team. Coale also oversaw the operations in MotherRock's Houston office.

It is believed that MotherRock had been shorting natural gas when prices spiked (Epoch Times). Per the Epoch times article, Steven Schork, analyst and publisher of the Schork Report, was cited as calling for more implosions:

"I actually have clients speculating that MotherRock is not the only fund that's imploded. It's like the cockroach theory: A light has been turned on and MotherRock has been exposed. Just when the light turns on, all the other roaches go scurrying under the refrigerator."

"I wouldn't be surprised if and when -- and it doesn't necessarily have to happen this week -- we find out another fund out there has been mortally wounded.

Schorks' comments seem prescient in light of the Amaranth collapse, which was only weeks away.

For further reading, check out this MotherRock round-up at iTulip. Regarding the leverage of hedge funds, Jon Najarian notes:

Toby [Smith] has continually cited the $1.4 trillion of global equity in hedge funds, and we know these hedge funds routinely leverage that capital to trade as if it were 10, 20 and as much as 100 times larger than it actually is. How do they do that? One popular way is through Joint Back Office arrangements with large investment banks.

Basically, the bank sells a percentage of itself for, say, $10,000. It might only be 1/10,000th of a single percent, but it allows the fund to trade on what's known in our business as "firm capital." This means that, unlike regular Joes and Janes, hedge funds do not have to meet Reg-T requirements, which is what the Federal Reserve Board requires investors to put up as a minimum deposit for their securities purchases.

Reg-T decrees that investors must have available a minimum of 50% of the funds for the purchase of marginable securities, also known as initial margin. Imagine how big you could trade if you didn't have to post 50% of the purchase price. The mind reels!

The reason why I bring up the leverage that hedge funds enjoy is that, like fire, it can be helpful or harmful. Put another way, you can use fire for good, to cook your food -- or you can get cooked instead. And in the investing world, given the massive positions you can put on with minimum dollars, the cooking happens at light-speed!

Back in the day, I would use $5 million to $10 million in capital to take down more than $300 million in positions, so you can imagine what damage a 27-year-old can do with a billion dollars under management!

I'm not sure we'll have to imagine much longer. We all know the saying about "playing with fire" ...

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Important: This fund is on our list of hedge funds that have "imploded" (see also ailing lenders). However, please note that "imploded" is a somewhat subjective. The "imploded" list contains hedge funds (or other unregulated and autonomous speculative investment funds) which have gone through some sort of permanent adverse change. This is a somewhat subjective call, and does not necessarily mean total shutdown or bankruptcy. It can also mean steep and rapid mark-downs in net asset value; or abnormal "bail-out" by corporate parents or peers in order to avoid write-downs and provide liquidity. The funds are of any type and sector.