The city hired the hedge-fund managers over the last year to invest $245 million of Philadelphia's pension portfolio. Amaranth is one of more than 100 hedge funds the managers have selected for the pension portfolio; as a group, the hedge funds have been profitable, McDonough said.
The city has more pensioners than active workers. Like many pension plans, it faces a growing deficit between the fund's assets and its expected liabilities.
As of June 30, the system could count on just 53 cents in pension assets for every $1 in future liabilities. Unless it can reduce that gap, the city will be forced to increase its subsidies to the fund, boost contributions to the fund from city workers' paychecks, or reduce pension benefits for future pensioners.
Philadelphia pension managers, like their counterparts at the Pennsylvania State Employees' Retirement System and the New Jersey Division of Investment, have turned to hedge funds - which include a wide variety of private investment firms that enjoy exemptions from Securities and Exchange Commission regulations - in hopes of boosting returns and avoiding the volatile price swings of stock and bond markets.
Hedge-fund advocates say the funds are able to provide better, or at least more stable, results than traditional stock and bond funds because their proprietary trading methods are shielded from public scrutiny and cannot easily be copied. Critics worry that hedge funds' secrecy makes it harder to prevent dangerous trades that occasionally lead to costly blowups, such as Amaranth's.
The Pennsylvania system, with around $30 billion in assets, has more than $60 million invested in Amaranth, while New Jersey's $70 billion state workers' and teachers' pension system has around $25 million in Amaranth. The Pennsylvania state teachers' pension fund avoided Amaranth; it does not invest in hedge funds.
The largest share of the city's exposure to Amaranth's losses is through Arden Asset Management L.L.C. of New York. The Board of Pensions and Retirement invested $50 million in Arden last year, according to city records.
Arden officials would not comment, but a person familiar with the firm said only around 3 percent of its $13 billion in total investments had been placed with Amaranth, and its other investments have been generally profitable. Some Arden funds may have invested more, the person said.
Other managers who invested Philadelphia funds in Amaranth include Allianz Hedge Fund Partners of San Francisco, Rock Creek Group of Washington, and New Market Capital Partners of Philadelphia.
Rock Creek officials would not comment on their Amaranth investments. Allianz and New Market officials did not return calls seeking comment.
The city has hired outside managers to help screen out dangerous, inappropriate or unproductive investments, which have created past losses.
Last year, the pension system wrote off $3 million invested in the former GS Capital of King of Prussia, a franchising firm run by Reggie White, the late former Philadelphia Eagles star, and his partners, and $800,000 invested in the 1990s in the United Bank of Philadelphia, a bank that earned disappointing profits.
Among the Philadelphia hedge-fund managers that avoided Amaranth is Attalus Capital Management of University City. "They're really proud" of having dodged the Amaranth bullet, McDonough said. Attalus did not return a call seeking comment.
Other city hedge-fund managers that did not buy into Amaranth include a fund managed by Goldman Sachs & Co. of New York, and two managed by Mesirow Financial of Chicago.
Philadelphia has attempted to diversify its investment portfolio along lines similar to those adopted by the Pennsylvania state workers' pension fund, which has nearly $6 billion, or 20 percent, of its assets in hedge funds.
For example, Pennsylvania has about $1.2 billion invested in Morgan Stanley Institutional Fund of Hedge Funds, a West Conshohocken-based group that invests in 30 hedge funds, including Amaranth. Pennsylvania's investment accounts for about half the fund's total capital.
Amaranth is at least the third hedge fund chosen by the Morgan Stanley team to have suffered large losses since the fund was started in 2002.
The Morgan Stanley fund had to write off a $15.6 million investment in Lancer Partners L.P. after Lancer declared bankruptcy in 2003. And the fund wrote down $10 million of its $18.8 million investment in Safe Harbor Fund L.P., after the SEC appointed a receiver for the firm amid a dispute with other investors.
The Morgan Stanley fund has an investment in Amaranth that was worth $123 million as of June 30; losses could reach $80 million, based on Amaranth's reports to investors.
However, Morgan Stanley says the other 27 hedge funds in the portfolio are largely profitable. The fund reported profits that trailed the Standard & Poor's 500 by at least 50 percent during the bull market years 2003 and 2004, but reported market-beating gains as U.S. stocks slowed last year and the first half of this year.
Contact staff writer Joseph N. DiStefano at 215-854-5957 or firstname.lastname@example.org.