Expect more unwinds

2016-02-19 7pm EDT  |  #Citadel #Ken Griffin #gold #hedge funds

A few days ago I started hearing rumours about a big hedge fund that was short of pile of gold. Traders were blaming the hedge fund’s aggressive short covering for the quick rise in price.

And sure enough, yesterday we learned that Citadel’s Ken Griffin had laid off almost a dozen staff members from his internal “Surveyor” fund. What had previously just been rumours was confirmed by the WSJ:

Hedge-fund giant Citadel cut more than a dozen members of its investment staff this week in the wake of early losses for the firm in 2016. The Chicago-based firm, led by billionaire Kenneth Griffin, parted ways with analysts, associates and portfolio managers in its multibillion dollar Surveyor Capital arm. Surveyor is one of Citadel’s three internal units that bet on and against stocks worldwide. Last month, the firm replaced the longtime head of Surveyor, Jon Venetos. The unit recently had about 200 employees, with a majority considered investment staff. The moves come as Mr. Griffin grapples with a money-losing stretch unusual for one of the hedge-fund world’s marquee names. As the Wall Street Journal reported in a Page One story last year, Citadel has been in an aggressive and profitable expansion mode since suffering heavy losses during the financial crisis. Through the second week of February, Citadel’s main fund is down 6.5% this year, a person familiar with the matter said.

We obviously have no way of knowing whether Citadel’s Surveyor fund was the big buyer of gold. Although I think they might have contributed to the rise, I doubt their buying caused it.

I am more interested in Citadel’s poor performance. Although Griffin struggled more than most of his hedge fund manager peers during the 2008 crisis (down 54%), since then he has blown the barn doors off. He hasn’t returned less than 11% for any year since the financial crisis.

He has been rock steady and has attracted assets at a fierce rate.

Even CNBC refers to him as “King Ken”:

The firm’s resurgence has arguably made Griffin the most powerful figure in hedge funds. The 46-year-old’s personal fortune increased more than any other hedge fund manager’s in 2014, an estimated gain of $1.3 billion, according to Alpha.

Griffin is worth an estimated $6.6 billion, placing him seventh on the Forbes ranking of investor billionaires. But those above him are either managing just personal capital (George Soros, Jim Simons and Steve Cohen) or performed relatively poorly last year (David Tepper and John Paulson).

The only more prominent person than Griffin is perhaps Ray Dalio of Bridgewater Associates, the largest hedge fund manager in the world. But Dalio, 65, has been slowly delegating control of the firm he founded in 1975. He remains as involved in investment decisions as ever, but is now assisted by two co-chief investment officers (a title he shares). Operations are led by separate co-CEOs and a president.

Griffin remains firmly in control of Citadel, which he launched with the backing of hedge fund pioneer Frank Meyer in 1990 shortly after graduating from Harvard. At Harvard, Griffin famously traded bonds using a satellite dish he installed on the roof of his dorm.

But the question of how much this great “performance” was merely surfing the financial asset QE induced levitation hangs in the air like a bad smell.

And most worryingly, the amount of leverage Citadel uses to generate these returns is more than most other large hedge funds:

My suspicion is Citadel was perfectly suited to the low volatility Fed induced financial asset bull market. Now that those days are gone, how quickly will they be able to transition to a new environment?

Don’t get me wrong - I am not trying to crap all over Ken’s firm. Anyone who has gotten rich enough to blow half a yard on a couple of paintings probably pays more in sales tax per year than my entire net worth.

But I want to make the point that something has changed. Although King Ken is still writing big cheques to impress his other 0.0001%‘er friends, the market no longer agrees with his positions.

And if ZeroHedge’s sources are correct, there is still some unwinding to do:

What the WSJ did not note is that “now there is a desperate scramble to try to unwind a massively leveraged equities portfolio (over $50 billion gross).”

Our source concludes that “Citadel investors do not know the truth of what is happening here. They are trying to maintain the illusion but there is chaos amongst employees.”

As is always the case on Wall Street, a good trade was taken much, much too far. In this case, the Federal Reserve was right to save the system with QE1, but the next three programs simply enriched the Ken Griffin’s of the world. And of course, there is no way these hedge fund managers as a group will all be able to exit at the same time.

I expect more dramatic unwinds in the months to come. Just be aware it doesn’t always mean asset prices will go down. Some of these trades involved shorting commodities such as gold and oil. The covering of these positions could mean some dramatic movement downward in financial assets with corresponding rips higher in commodities. Don’t forget the trade of buying financial assets while selling real assets has been the main money maker for the past half decade.

Thanks for reading and have a great week end,
Kevin Muir
the MacroTourist