“Our performance is driven by the extraordinarily talented people at Citadel,” Scully said. “We have the best investment team in the industry.”
Yet Citadel is the only one of its main competitors that has almost imploded. In 2008, its main fund lost 55%, or roughly $9 billion — mostly in convertible, high-yield and investment-grade bonds and bank loans. At the time, Citadel was managing less than a third of the assets it oversees today. Since then, Citadel has said it learned from the episode and avoids illiquid investments.
Millennium, Citadel’s closest competitor, produces steadier returns. Its annualized swings in performance are less than 4%, according to a Bloomberg analysis. Englander’s firm, which manages about $60.6 billion, has generated annualized returns of 14% since its founding in 1989. Dmitry Balyasny’s hedge fund has a similar profile.
Much of the increased regulatory focus has been in Treasury markets, where leverage tends to be the highest. Hedge funds in aggregate had estimated leverage of 56-to-1 on $553 billion of Treasury repo borrowing as of December 2022, according to a September research note by Federal Reserve staffers Ayelen Banegas and Phillip Monin.
That’s why many of the big firms incurred larger-than-expected losses during the early days of the Covid-19 pandemic. They were caught in the so-called basis trade, which is designed to profit from small differences between Treasury futures and the cash market. Considered a safe arbitrage bet if held to maturity, it can occasionally go haywire, as it did in March 2020. The Fed was forced to step in to calm markets, pledging $5 trillion of stimulus.
A succession of mini quakes — including March 2020 — prompted the Bank of England to include Citadel, Millennium, LMR Partners and Steve Cohen’s Point72 Asset Management, as well as other hedge funds, in its stress tests.
LMR, an $11 billion pod shop with no down years until then, was among the biggest casualties that month. It had made highly leveraged trades, wagering around volatility arbitrage, dividend arbitrage and the basis trade. As bets across the industry imploded, its main LMR Multi-Strategy hedge fund plunged by a record 24% — mostly hit by vol arb — according to investor letters seen by Bloomberg. Meanwhile, the LMR Alpha Rates Trading Fund, which counts the basis trade as a key strategy, lost 4%, also its worst month ever, the letters show.
In response, the firm exited strategies including relative value trading in credit, equity index and cross asset. It shut the LMR Long Horizon Fund after its bets on volatility backfired. The firm also bolstered its risk-management team, appointed product heads and embarked on a more rigorous monitoring of its portfolio managers. The multistrategy fund ended the year down 6%, its only annual loss since its debut. The rates fund fully recovered.
Losses rippled through almost every big multistrat shop, and at least one trader likened the panic to the 2008 financial crisis.
While interviewing Griffin last month at an event in New York, fellow billionaire Paul Tudor Jones said his hedge fund’s basis-trade book was in “extreme duress” in March 2020 and that the Fed’s action bailed him out. Griffin replied that Citadel was down as well, but that “it wasn’t meaningful,” relative to the firm’s capital base.