Citadel Loves a Company in Misery

Sowood's Troubled Debt
Drew a Rapid Response

By GREGORY ZUCKERMAN
August 1, 2007; Page C1

Where there's trouble in the markets these days, there's usually Kenneth Griffin.

On Sunday, Mr. Griffin, the 38-year-old founder of big Chicago hedge fund Citadel Investment Group, first learned about deep troubles at hedge fund Sowood Capital. He called a team of 30 traders at their homes and told them to come into the office, trying to figure out a way to profit from the problems. On Monday, Citadel bought up many of Sowood's investments, including bond positions that were rapidly losing value.

For Sowood, it was a way to salvage something from the losing securities. The Boston-based hedge fund has seen its investments drop more than 50% in value in just the past few weeks, in part because it used borrowed money that amplified its losses. It will give the money it now holds, about $1.5 billion, back to its investors as it winds down its two hedge funds. That makes it the most high-profile hedge fund to collapse in the continuing bond-market difficulties.

The sale to Citadel was just the latest example of how Mr. Griffin's firm, which manages about $15 billion, likes to try to profit as others in the hedge-fund world face misery.

Last year, Citadel assumed a number of energy positions held by hedge fund Amaranth LLC after it suffered sharp losses. Citadel eventually profited from the transaction. The firm also indirectly purchased bonds from Long-Term Capital Management when the hedge fund imploded in 1998, as well as energy assets as Enron Corp. collapsed. Citadel traders make calls every day to Wall Street desks, asking if there is a need for a buyer of distressed assets, say people close to the firm.

"When crises happen, we're well-situated to assess the situation and deploy capital," says Mr. Griffin in an interview. "But we want to be a go-to player for any large trade, in good or bad times."

So far, Citadel has scored some profits on the deal with Sowood. Risky debt has gained value in the last two days, helped in part by Citadel's own move, which gave courage to other investors to buy troubled debt.

Mr. Griffin, seen as a boy wonder in the hedge-fund world who traded options as an undergraduate at Harvard, launched Citadel in 1990 with less than $5 million. Known as a hard-driving manager, Mr. Griffin's firm has suffered just one money-losing year. Investment records provided by an investor show few months when the hedge fund has lost money.

Citadel pursues a range of investment strategies beyond being buyer of last resort for troubled investment firms, from quantitative trading programs to more traditional stock picking. It has racked up gains of almost 20% so far this year, according to an investor.

Critics and even some of the firm's own investors say a good chunk of the firm's top-notch returns are a result of ample leverage, or borrowed money, that the firm employs. That can add to gains in good times, but also to losses when things go wrong.

Behind the bravado of buying when everyone else is selling, Mr. Griffin has a strategy: Citadel does so much daily trading in so many markets that when crises hit, the firm's traders have a perspective on each market and believe they can accurately value even investments that are trading infrequently and can be hard to put a price on.

Citadel also has invested heavily in its risk-measurement systems and sits on a lot of capital, aiding its bargain hunting. The firm likes to make rapid-fire decisions, hoping to strike before rivals.

"Our business is to have a view and to be active participants in all markets each and every day," says Mr. Griffin. "So, when dislocations occur, because we already have expertise in the asset classes and have a great team in place, we can step in."

Citadel is now among the first to get calls when others in the hedge-fund world get in trouble, much like Warren Buffett routinely receives requests from companies when they are desperate for capital. And the more deals Citadel does, the more Mr. Griffin is seen as standing ready with cash for similar deals in the future, especially for complex situations that can give rivals pause.

Still, the strategy could become harder for Citadel to pull off in the years ahead. A number of other hedge funds, such as Eric Mindich's Eton Park and other investment firms, have raised money or are hoping to do so, so they will have dry powder to use in difficult times for the kind of bargains that attract Citadel.

But so far, Citadel has been the one spending when times are bad. Few others have pulled the trigger on big deals. In the Amaranth situation, other firms, such as J.P. Morgan Chase & Co., got involved, but few other hedge funds besides Citadel made sizable bids for Amaranth's assets.

The groundwork for the Sowood deal was set last week as Mr. Griffin vacationed in France with his wife, who is French. As debt markets suffered, Mr. Griffin's thoughts turned to how Citadel could take advantage.

By late last week, Mr. Griffin emailed clients that he thought the markets had gone too far, given how robust U.S. and world economies remain, and that his firm was looking to do some buying. He instructed his 30-member team that trades bond-related products to look for opportunities, and the Sowood deal fit the bill.

Write to Gregory Zuckerman at gregory.zuckerman@wsj.com