Citadel increased earnings moe than fivefold

Citadel Investment Group LLC, thehedge-fund manager founded by Kenneth Griffin, said earnings by its two largest funds increased more than fivefold on gains fromdebt 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 firmtold investors this week in a prospectus for its first bond sale.The fund, which has $9.5 billion in assets, returned 7 percent inthe third quarter, compared with 3.1 percent a year earlier, whenits corporate-debt and energy bets lost money. ``Citadel hired a significant number of new investmentprofessionals since mid-2005 to strengthen both the global creditand global energy business,'' the Nov. 27 document said. Earningsat 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 byBloomberg News, details the finances of the closely held firm,which oversees almost $13 billion for wealthy investors andinstitutions. Hedge funds, private pools of capital that allowmanagers to participate substantially in their investment gains,oversee $1.3 trillion, more than double what the industry'sassets were five years ago. Institutions such as pension funds and endowments havecontributed about $361 billion to hedge funds, according to anOct. 10 report by Bank of New York Co. and consulting firm Casey,Quirk & Associates LLC in Darien, Connecticut. That amount maytriple by 2010.

Kensington's Returns

Hedge funds have struggled to outperform market indexes as aflood of cash from investors has made it harder to make money.Kensington 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 8.5percent including dividends. Operating costs at Citadel's two main funds rose 20 percentthis year to $805.1 million, the prospectus said, as the companyhired 320 employees since the beginning of 2004. Performance-based compensation is a ``significant part'' of those costs. Thecompany currently has 1,070 employees, including 656 investmentstaffers. Unlike most hedge funds, investors in Citadel funds pay allexpenses. Their costs rose to 8.75 percent of assets in 2005 from4.66 percent in 2003, the prospectus said. Kensington had netwithdrawals of $657.6 million through Aug. 31. For all of 2005,the fund had net inflows of $61.7 million.

Using Leverage

Hedge funds seek to magnify their gains by using borrowedmoney to increase their bets. Citadel's funds borrowed 7.8 timestheir assets as of Aug. 31. Their investments include corporatedebt, energy, stocks, currencies and government bonds, andreinsurance. JPMorgan Chase & Co., the third-biggest U.S. bank, sold itshalf of Amaranth Advisors LLC's energy trades to Citadel for $725million less than two weeks after taking over the positions.Amaranth, reeling from more than $4.6 billion in losses,transferred its energy investments to JPMorgan and Citadel onSept. 19. Citadel bought JPMorgan's share of the natural-gas,power and oil trades on Sept. 29, Citadel said in its prospectus. Bryan Locke, a spokesman for Chicago-based Citadel, declinedto comment. Griffin, 38, started Citadel in November 1990 with $4.6million, three years after he began trading convertible bonds outof his dorm room at Harvard University. Kensington opened with$5.5 million in 1995.

First for Hedge Fund

Institutional investors and so-called funds of funds make upabout 62 percent of the firm's investment capital as of Sept. 30,according to the prospectus. Citadel principals and employeescontributed about 15 percent. Citadel plans to sell bonds as a means to cut its relianceon financing from Wall Street investment banks. In a first for ahedge fund, the firm may sell $500 million of the notes next week,said a person familiar with the offering. Citadel could raise asmuch as $2 billion over time, according to the prospectus. Citadel in January is scheduled to start Citadel SolutionsLLC, which will handle administrative chores such as settlingtrades and valuing holdings for its own funds and other hedgefunds. Citadel said it expects the move to cut fund expenses.