Mulligans of the Rich and Famous

“A Hedge-Fund King Comes Under Siege”

I was struck by today’s article in The Wall Street Journal. Last year Citadel Investment Group lost about 55 percent in its flagship funds. This year the main fund is up 58 percent, and Citadel’s founder is raising new money. But investors, still licking their wounds from 2008, are resisting.teeGolf

In a September interview in his Chicago office, Mr. Griffin expressed exasperation at investors’ desire to keep dissecting last year’s disaster, comparing their fascination with people’s inability to look away from a car crash. “I’ve told the story of 2008 many times,” he said.

Note to Griffin at Citadel: You’re still down, pal.

As a financial adviser, I understood the pain of “Siegel’s paradox.” If an investor loses 50 percent one year and earns 50 percent the next, the investor is still down. Citadel’s actual numbers illustrate this point. Assume an investor started with $1 million on January 1, 2008. It was worth approximately $450,000 by year end. That $450,000 has grown to $711,000, if the 58 percent year-to-date gains hold.

Here’s where “high-water” marks take effect. Many hedge funds forego their 20 percent performance fees until investors recoup their initial capital—$1 million in our example above. “High-water” marks create incentives, however, for either funds to raise new capital or employees to jump ship and start their own firms.

They have no ground to make up, so they can earn fees immediately. In the first quarter, Citadel told investors it was hoping to raise more than $2 billion over several years for a new fund designed to invest in currencies, interest rates and broad economic trends.

Note to Hedgistan: We don’t want you taking mulligans with our money.

What’s the point of agreeing to a high-water mark if you circumvent it? Through October, Citadel had only raised $500 million across all its investment disciplines. Frankly, I’m surprised they raised $1 before existing investors returned to par.

Note to new money: How will you feel when your hedgies start yet another fund and you’ve lost your shirt?

These “do overs” infuriate me. Why pay 20 percent of the upside during an economic bounce to the same guys who were torching investor capital on the way down? We’re lining hedgie pockets while the rest of America is struggling. Let’s get real here.

Here’s another reason to rant. Many hedge funds negotiate the right to limit redemptions. So as Citadel is asking for money with one hand, it is also preventing more than $1 billion dollars in redemption requests with the other.

Note to investors: Read your subscription documents.

My bet is that government will regulate hedge-fund compensation over the next year. The private jets and fabulous art collections—I’m not referring only to Citadel—make for easy targets. But perhaps I’m wrong. Those same deep pockets fund political races.

Note to Congress: Why not forego campaign contributions from money managers as you regulate the financial services industry?

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