In the aftermath of his disastrous 2008 losses, Citadel founder Ken Griffin is reportedly going out on marketing meetings to raise money for the firm’s new hedge funds -- part of an effort to bring in assets that have some hope of generating near-term performance fees while the firm’s older funds remain below their high-water marks. Griffin is nothing if not a survivor, but one has to question whether last year’s losses were a product of misfortune or of underlying structural difficulties at Citadel, as AR examined in its December 2008 cover story, Can Citadel come back? The question remains. Here, an excerpt from that story:
The biggest irony is that most of Citadel’s recent losses came in its convertible book - the very place where Griffin started out. In late September, a month in which it lost 16.22%, Citadel was already getting hurt in converts, as a result of fallout from the Lehman bankruptcy. Believing that converts were at “fire sale” prices, Citadel told investors that it was adding to the position, which then got pummeled in October. The leverage - still more than three times equity - also added to the pain, and to investors’ chagrin. “What most disappointed us was that we thought he had figured out the risk management piece,” says one disgruntled investor. “There was just too much leverage. So whatever his convert position was, it was too big, certainly for the amount of leverage on it.” Indeed, investors have discovered that leverage has been a big piece of the killer returns Citadel funds has long posted. In the fall of 1998, Citadel ramped up leverage from about three times to at least six times. Leverage was near eight times in late 2006. Earlier this year, S&P reported that gross leverage was 8.2 times on January 31, with net leverage at 5.2 times. In recent weeks, it has been difficult for Citadel to reduce net leverage lower than the 3.5 times equity it disclosed in October because even as it reduces risk, the losses it has since experienced deplete its capital, which increases leverage. Historically, Citadel’s view has been that its huge investment in technology - about 400 of the firm’s 1,300 employees are dedicated to technology - and the associated risk management systems would allow the firm to use leverage wisely. But the massive infrastructure didn’t pay off, at least this time. “That’s the elephant in the room - his estimation of risk was wrong,” says a former executive.
