Citadel Hedge Fund Falls 30% on Bond, Stock Losses

By Katherine Burton
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Oct. 16 (Bloomberg) -- Citadel Investment Group Inc.'s biggest hedge fund fell as much as 30 percent this year, because of losses on convertible bonds, stocks and corporate bonds, said two people familiar with the Chicago-based firm.

Kenneth Griffin, who founded Citadel in 1990, said in a letter to investors this week that returns for the $10 billion Kensington Global Strategies Fund may swing wildly as markets are battered by the global credit crunch. Griffin holds 30 percent of the firm's $18 billion of assets in cash, according to an Oct. 8 report by Standard & Poor's.

``In the weeks to come, I expect we will continue to see significant volatility in our earnings as the world manages through the unfolding crisis,'' wrote Griffin, 40. ``It is incumbent upon us to navigate through this period and to create value for our stakeholders over the years to come.''

Kensington's loss, more than double the decline of the Credit Suisse/Tremont Hedge Fund Index, may dent Griffin's reputation as a consummate risk manager with no patience for traders who can't make money. Kensington's only annual loss was a 4 percent drop in 1994.

Katie Spring, a Citadel spokeswoman, declined to comment.

Citadel may have difficulty selling convertible bonds, which accounted for about a quarter of the loss, because there is little demand. The market tumbled 13 percent in October, according to a Merrill Lynch & Co. index. The benchmark is down 21.5 percent since the end of August.


``It's very hard to get out of positions,'' said Tom Sowanick, chief investment officer at Clearbrook Financial LLC in Princeton, New Jersey, which manages $22 billion.

Not Pessimistic Enough

Convertible bonds are debt securities that can be converted into stock. They usually gain most when the difference between yields on corporate bonds and U.S. Treasuries is narrowing and the stock market is rallying. That hasn't been the case most of the year. By the end of September, Kensington was down about 23 percent year-to-date.

Griffin told investors his main mistake was not being pessimistic enough about the extent of the financial crisis, which began in 2007, a year he described in his letter as ``the most successful in the history of the firm.'' Last year, Kensington climbed about 30 percent.

``Regretfully, I did not foresee the financial disaster that was to unfold in September,'' Griffin wrote in the letter, a copy of which was obtained by Bloomberg News.

September was the worst month for convertible bonds since 2001. The market fell as hedge funds found it hard to borrow in the wake of the Lehman Brothers Holdings Inc. bankruptcy and the U.S. Securities and Exchange Commission temporarily banned short selling of more than 900 stocks.

Stock Losses

In a short sale, a trader borrows stock and sells it in the hopes it can be bought back later at a cheaper price. The restriction, which was lifted Oct. 8, prevented investors from hedging the risk that convertible bonds would fall in value.

About a quarter of Citadel's losses in September came from stocks, as industrial, technology, communications, media and entertainment shares all tumbled, according to the letter.

Citadel's wagers on corporate debt and structured credit also lost money as did trades on energy, reinsurance and mortgages, it said.

The fund's bets on macroeconomic trends using stock indexes, bonds, currencies and commodities was the only strategy that made money in the month.

Citadel executives have been outspoken about their expectations for traders to make big returns even in difficult markets.

No Apologies

``When the markets change, we don't accept lower returns,'' said Mike Pyles, Citadel's head of human resources in a 2005 interview. ``We aren't that kind of firm. We expect the manager to go figure out how to make money in the new markets. We make no apology for it.''

Even with the losses, Griffin continues to take steps to turn Citadel into a diversified financial firm. He is close to hiring a senior executive for his capital-markets business, according to a person familiar with the matter. At the beginning of the year, Citadel separated that business, which includes an options market-making group and a service that handles administrative chores for hedge funds, from its money-management operations. The options market-making group has returned about 30 percent this year.

Citadel also plans to start single-strategy hedge funds, including a fixed-income fund, a macro fund and a convertible- bond fund. These funds will charge investors 2 percent of assets and 20 percent on any investment gains. Citadel's current funds also get 20 percent of any gains, and instead of paying a management fee, clients cover the fund's expenses.

To contact the reporter on this story: Katherine Burton in New York at kburton@bloomberg.net