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Citadel Says Hedge-Fund Profit Rose Fivefold in 2006

Date: Wednesday, November 29, 2006
Author: Katherine Burton and Miles Weiss, Bloomberg.com

(Bloomberg) -- Citadel Investment Group LLC, the hedge-fund manager founded by Kenneth Griffin, said earnings by its two largest funds increased more than fivefold on gains from debt and energy investments.

Net income at Citadel Kensington Global Strategies Fund Ltd. rose to $795.6 million in the first eight months of 2006 from $148.4 million in the year-earlier period, the Chicago-based firm told investors this week in a prospectus for its first bond sale. The fund, which has $9.5 billion in assets, had an investment return of 7 percent in the third quarter, compared with 3.1 percent a year earlier, when its corporate-debt and energy bets lost money.

``Citadel hired a significant number of new investment professionals since mid-2005 to strengthen both the global credit and global energy business,'' the Nov. 27 document said. Earnings at its Wellington LLC fund, which has $3.3 billion in assets, rose to $389.1 million from $54.3 million.

The 363-page prospectus, a copy of which was obtained by Bloomberg News, details the finances of the closely held firm, which oversees almost $13 billion for wealthy investors and institutions. Hedge funds, private pools of capital that allow managers to participate substantially in their investment gains, oversee $1.3 trillion, more than double what the industry's assets were five years ago.

Institutions such as pension funds and endowments have contributed about $361 billion to hedge funds, according to an Oct. 10 report by Bank of New York Co. and consulting firm Casey, Quirk & Associates LLC in Darien, Connecticut. That amount may triple by 2010.

Kensington's Returns

Citadel's Kensington fund returned 17 percent this year through Sept. 30, compared with the average 8.8 percent for similar hedge funds, according to Chicago-based Hedge Fund Research Inc. The Standard & Poor's 500 Index, a benchmark for U.S. stocks, returned 8.5 percent, including dividends, in the same period.

Hedge funds seek to magnify their gains by using borrowed money to increase their bets. Citadel's funds borrowed 7.8 times their assets as of Aug. 31. Their investments include corporate debt, energy, stocks, currencies and government bonds, and reinsurance.

Citadel plans to sell bonds as a means to cut its reliance on financing from Wall Street investment banks. In a first for a hedge fund, the firm may sell $500 million of the notes next week, said a person familiar with the offering. Citadel could raise as much as $2 billion over time, according to the preliminary prospectus.

Bryan Locke, a spokesman for Chicago-based Citadel, declined to comment.

Fund Expenses

Citadel in January is scheduled to start Citadel Solutions LLC, which will handle administrative chores such as settling trades and valuing holdings for its own funds and other hedge funds. Citadel said it expects the move to cut fund expenses.

Operating costs at Citadel's two main funds rose 20 percent this year to $805.1 million, the prospectus said, as the company hired 320 employees since the beginning of 2004. Performance- based compensation is a ``significant part'' of those costs. The company currently has 1,070 employees, including 656 investment staffers.

Unlike most hedge funds, investors in Citadel funds pay all expenses. Their costs rose to 8.75 percent of assets in 2005 from 4.66 percent in 2003, the prospectus said. Kensington had net withdrawals of $657.6 million through Aug. 31. For all of 2005, the fund had net inflows of $61.7 million.

Amaranth Profit

Citadel's profits this year were boosted by its takeover in September of the energy portfolio of Amaranth Advisors LLC, which had been crippled by $4.6 billion in trading losses. The funds' energy returns were about 3 percent in the month, compared with total gains of 4.5 percent for Kensington and 4.9 percent for Wellington, the firm said in the document.

Amaranth, based in Greenwich, Connecticut, transferred the holdings to Citadel and JPMorgan Chase & Co. on Sept. 19, and Citadel bought JPMorgan's share of the natural-gas, power and oil trades on Sept. 29 for $725 million, according to the prospectus.

Citadel and New York-based JPMorgan received an unspecified ``concession payment'' from Amaranth for taking on the risks of the trades, the prospectus said. By buying out JPMorgan's half, Citadel received the remaining concession payments from Amaranth.

Citadel Employees

Griffin's managers absorbed the Amaranth holdings, reduced the risks of the trades and set aside reserves to reflect current market value, the prospectus said, without providing details. By Oct. 15, Citadel's energy portfolio had about one-third the risk of the original Amaranth trades.

Griffin, 38, started Citadel in November 1990 with $4.6 million, three years after he began trading convertible bonds out of his dorm room at Harvard University. Kensington opened with $5.5 million in 1995.

Institutional investors and so-called funds of funds make up about 62 percent of the firm's investment capital as of Sept. 30, according to the prospectus. Citadel principals and employees contributed about 15 percent, the most of any group of investors.

To contact the reporters on this story: Katherine Burton in New York at kburton@bloomberg.net ; Miles Weiss in Washington at mweiss@bloomberg.net .