财经观察 2198: Griffin Shifts Funds Strategy to Fortify Citadel

Griffin Shifts Funds’ Strategy to Fortify Citadel (Update1)
2009-09-15 22:56:47.773 GMT

    (Adds Griffin comment in sixth paragraph.)

By Katherine Burton and Saijel Kishan
    Sept. 16 (Bloomberg) -- Ken Griffin started trading
convertible bonds 22 years ago from his Harvard University dorm
room. Now he’s moving away from the investments that made him a
billionaire hedge-fund manager -- and unraveled last year,
leaving clients with a 55 percent loss, almost three times the
industry average.
    Citadel Investment Group LLC, Griffin’s $13.5 billion firm,
is reducing its two biggest funds’ holdings of convertible bonds
and other so-called relative-value trades that try to profit
from small price differences in related securities, and amplify
the gains with debt. At last year’s peak in May, the firm used
borrowings of nine times net assets to hold $145 billion in
gross assets. That was triple the average leverage ratio of
hedge funds, according to a report from JPMorgan Chase & Co.
    Griffin, 40, boasted a 26 percent annualized return in his
first 17 years of business. Last year he suffered his biggest
loss as the funds sold assets to reduce borrowings.
    “This was the first time in 20 years that we have played
defense,” Griffin, president and chief executive officer, said
in an interview at Citadel’s Chicago headquarters, after
recently returning from Europe, his first vacation since the
bankruptcy of Lehman Brothers Holdings Inc. a year ago. “In
other crises, we had enough firepower in reserve. We could be
buyers.”

                       Shift in Strategy

    Still, he has hired 70 people to operate a full-service
investment bank, which he says will compete with Goldman Sachs
Group Inc. and Morgan Stanley. He started three hedge funds,
which are being marketed around the world by a six-person team.
And his flagship funds, Kensington and Wellington, have returned
about 52 percent through Sept. 1, in part on a rebound in
convertible bonds.
    “It was an incredible time in market history,” said
Griffin. “Today our team is solidly focused on the future.”
    His shift in investment strategy, he said, involves relying
more on fundamental research to make trades than on bets based
on the historic relationships between two securities.
    That may not satisfy some of the 300 or so clients in
Kensington and Wellington, which would have to return an
additional 46 percent each to make investors whole and to
collect performance fees.
    Citadel suspended redemptions last year as investors sought
to pull about $1.5 billion in assets. It’s set to release $250
million at the end of this month, and Griffin said he expects
more than $500 million will be returned to investors by the end
of the year.

                    Investor Disappointment

    One longtime Citadel investor, Jean-Francois Vert, CEO of
Allianz Alternative Asset Management in Paris, said he plans to
reduce his position.
    “We are very disappointed by the poor liquidity and
performance of Citadel,” Vert said, adding that he favors any
strategy shift that allows the firm to reduce leverage and give
money back to investors.
    Griffin, who founded Citadel in 1990 at the age of 22 with
$4.6 million, built what investors and other managers considered
a formidable business that lived up to its name: an impenetrable
fortress. He did it by buying when others were in trouble. By
the end of 2007, he was managing $21 billion, trading everything
from U.S. stocks and energy to corporate bonds. His firm was the
13th largest hedge-fund manager that year, according to
Institutional Investor’s AR magazine.

                       Looking at Lehman

    Griffin made commitments of at least a year for 85 percent
of the funds he borrowed, unlike managers who focused on
borrowing money for six months or less. His investors were
locked up for as long as two years.
    “We built the firm to be invincible,” said Griffin. “Of
course our successes engendered our confidence.”
    The confidence led Griffin, along with a partner, to
consider buying assets of Lehman in the months before the New
York-based firm collapsed, he said.
    “There were a number of businesses at Lehman that were of
interest to us,” Griffin said.
    He declined to provide the name of the partner, describe
the assets they wanted to buy or say why the talks fell apart.
    Citadel’s first big distressed deal was in 2006, when it
took over the energy positions of Amaranth Advisors LLC, the
hedge-fund firm in Greenwich, Connecticut, that lost $6.6
billion betting on natural gas. The following year Griffin
bought most of the assets of Sowood Capital Management LP, a
Boston-based hedge-fund manager that closed after it lost 60
percent on wrong-way bets on corporate bonds and loans.

                            E*Trade

    Griffin’s biggest deal was in 2007, when he pumped $2.55
billion into E*Trade Financial Corp., the New York-based online
broker, including $800 million of securities tied to mortgages.
That trade has been profitable, said Chief Operating Officer
Gerald Beeson.
    As the financial crisis gathered steam in 2007, Griffin
continued to buy when others were selling. Citadel started
increasing its purchases of convertible bonds and added to the
positions in 2008 as the securities got cheaper. Convertible
bonds, which can be exchanged for stock once shares hit a
predetermined level, accounted for about 20 percent of Griffin’s
biggest funds last year.

                       ‘No Disagreement’

    After the forced sale of Bear Stearns Cos. to JPMorgan
Chase in March 2008, Griffin visited the 35th-floor office of
Brad Begle, Citadel’s head of convertible bonds. He told him to
buy more because they were cheap, according to people familiar
with the matter.
    Begle, who declined to comment, protested because he feared
the market would drop, according to the people. Griffin says the
two were of one mind about the size of the position.
    “There was no disagreement about the increase,” he said.
“There might have been a disagreement about the pace of the
increase.”
    By Nov. 30, the funds had about $13 billion in bets that
convertible-bond prices would rise, according to an investor
report. Another $8 billion was in positions that would profit if
stocks tied to those convertible bonds fell.
    The funds also lost money on high-yield bonds and
investment-grade bonds hedged with credit-default swaps, which
protect buyers in the event of a default. Citadel was betting
that the gap between the default swaps and the bonds would
narrow. Instead, they widened as lenders left the market and
investors bet that more companies would default.

                        Mounting Losses

    In the fourth quarter of the year, Citadel’s losses mounted
as markets for convertible bonds and loans went into a free
fall. Beeson, 37, was on the phone almost daily with lenders,
including Deutsche Bank AG, Goldman Sachs and at least 20
others, he said in an interview.
    The fund met collateral calls with cash, which dropped from
about 35 percent of assets to 20 percent by the end of the
fourth quarter. It sold stocks and other easily tradable assets
to replenish the cash.
    “Buying time was the most we could do,” said Griffin.
“You have to make sure you are generating cash well before the
moment you need the cash.”
    While Citadel executives say they expect the Kensington and
Wellington funds to continue to be the cornerstone of their
asset-management business, the firm has started three hedge
funds this year that focus on single strategies -- macroeconomic
trends, equities and convertible bonds. Citadel plans to start a
distressed-mortgage fund by the end of 2009 and a distressed
corporate-bond fund next year, Griffin said.

                          Fundraising

    The new funds are meant to appeal to clients who want to do
their own asset allocation, rather than invest in Citadel’s
multistrategy funds. Kensington and Wellington charge expenses,
which have ranged from 3 percent to 6 percent of assets, and
take 20 percent of investment gains. Griffin covered the expense
fees last year. The new funds are more in line with industry
standards of 2 percent of assets and 20 percent of gains.
    Citadel has raised about $500 million from new and current
investors for those funds since the second quarter, Griffin
said. New York-based Blackstone Group LP’s $25 billion fund of
funds group has attracted $2.5 billion this year, and Paul Tudor
Jones’s Tudor Investment Corp., of Greenwich, Connecticut,
raised $1.9 billion between March and July.

                        Return to Roots

    “Citadel’s impregnable position in the hedge-fund industry
is not as strong as it was before 2008,” said John Trammell,
president of New York-based Cadogan Management LLC, which
invests $3.7 billion in hedge funds and doesn’t have money with
Citadel. “It may be difficult for them to regain that status
following last year’s losses.”
    Jones and Louis Bacon, CEO of New York-based hedge-fund
firm Moore Capital Management LLC, have said this year that they
would return to their roots of investing in the most liquid
markets rather than harder-to-sell assets such as private
equity.
    While Griffin is moving away from his roots, he’s also
ratcheting down leverage. Citadel lowered its leverage ratio to
about 8-to-1 as of November, according to a Citadel investor
report.
    “I was where I wanted to be on that Friday” before Lehman
declared bankruptcy, Griffin said of his portfolio at the time.
“In retrospect, I wish I had had less leverage.”