Bloomberg News

Citigroup to Allow Managers to Own Part of Hedge-Fund Unit

February 28, 2012

(Updates with stock performance, history of Old Lane starting in sixth paragraph.)

Feb. 17 (Bloomberg) -- Citigroup Inc., the third-biggest U.S. bank by assets, will let managers of its hedge funds own part of the business ahead of rules that limit shareholders’ cash in the unit, Chief Operating Officer John Havens said.

Employees in the Citi Capital Advisors division, or CCA, will get a “significant” stake in managing the funds, Havens said in an interview. This will increase, he said, as New York- based Citigroup withdraws its own money and attracts outside investors to comply with the Volcker rule, which restricts deposit-taking banks from making bets with their own capital.

“Our competitors are an owner-operated model,” Havens said during an interview in his 39th-floor corner office at Citigroup’s Greenwich Street building in Manhattan. “It was always in the plans but you have to actually have a business that you’re comfortable with to go do it.”

Havens and Chief Executive Officer Vikram Pandit, 55, are seeking to replace the company’s cash in CCA with funds from outsiders as regulators draft the Volcker rule’s final language. The proposed rule would prohibit banks from owning more than 3 percent of hedge funds and private-equity funds and from investing more than 3 percent of Tier 1 capital in the funds.

“We’re trying to create a client-centric, alternative asset-management business, and this is the final stage of putting that in place,” Havens said. “Clients like independent asset managers.”

Citigroup advanced 19 cents, or 0.6 percent, to $32.90 at 12:20 p.m. in New York. The stock has gained 24 percent this year through yesterday after tumbling 44 percent in 2011.

Dorfman, O’Brien

Former Morgan Stanley executives Jonathan Dorfman and James O’Brien run CCA, which managed $18.2 billion in private-equity, venture-capital and hedge funds, Citigroup said in August.

Citigroup had at least $5 billion in the funds, a person familiar with the matter said in May. The company also invested about $800 million of its money in internal private-equity and hedge funds in the third quarter, according to a November regulatory filing.

Attracting external capital would help Citigroup withdraw its money without forcing the closure of funds that hold mostly company cash. If the firm wanted to keep $5 billion with CCA and comply with the Volcker rule’s 3 percent cap, the funds would have to contain $161.7 billion from outside investors, or 69 percent more than the bank’s current market value.

Citigroup didn’t provide details about how it would divest its ownership of the hedge-fund unit.

Top Managers

“The actual drafting of the terms are under way,” Danielle Romero-Apsilos, a Citigroup spokeswoman, said in an e- mailed statement. “Formulas are currently being negotiated that would allow CCA’s management to acquire a portion of Citi’s interest in CCA, including their ability to replace a portion of Citi’s existing capital with third-party capital.”

Offering a stake in CCA will help Citigroup attract top managers, Havens said. Hedge-fund managers typically earn 2 percent of the assets they oversee and 20 percent of the profit. The change follows a year in which some of the bank’s hedge funds posted losses, people with direct knowledge of the matter said. The Bloomberg aggregate hedge-fund index fell 5.2 percent in 2011.

The Strategic Credit Fund, which invests in riskier debt, fell about 13 percent, said one of the people, who spoke on condition of anonymity because the figures aren’t public. The fund, managed by Fred Hoffman, has about $200 million under management, almost all of which belongs to shareholders, the person said.

Rajesh Kumar’s Mortgage/Credit Opportunity Fund declined about 4.2 percent, two people said. The fund contains about $400 million, most of it Citigroup’s own cash, one person said.

Event Driven Fund

Mukesh Patel’s Event Driven Fund, which manages about $500 million, dropped 1.8 percent, one of the people said. Kevin Bespolka’s $250 million Global Macro Fund lost about 11 percent and the $150 million European Credit Opportunities Fund slid 2.8 percent.

Other funds gained. A $370 million municipal-bond fund managed by Craig Henick and Edward Sun climbed about 6 percent and Mark Franklin’s Emerging Markets Special Opportunities Fund, with $900 million under management, advanced 0.4 percent, according to the people.

Some of the managers used to work for Pandit and Havens at Old Lane Partners LP, the hedge fund the pair founded after they left Morgan Stanley in 2005. Citigroup bought Old Lane for $800 million in 2007 in a deal that ultimately led to Pandit becoming CEO later that year. The bank shut that fund in 2008, purchasing its assets and allowing investors to take their money out.

‘We Are Pleased’

Havens declined to give CCA’s performance for 2011. Citigroup doesn’t disclose the unit’s revenue or performance. Net income at the securities-and-banking division, which holds the company’s trading and investment-banking divisions, tumbled 24 percent to $4.86 billion in 2011.

“It can always be better,” Havens said. “But we are pleased with the performance in that, on an asset-weighted basis, we’re top quartile in our hedge-fund strategies.”

Pandit and Havens are among Wall Street bosses grappling with the implications of the Volcker rule, which also seeks to restrict so-called proprietary trading, in which banks’ trading desks make bets with shareholders’ funds. Citigroup shut a London-based proprietary trading unit earlier this year with most of its staff leaving the bank, according to an internal memo obtained by Bloomberg News at the time. Morgan Stanley and Goldman Sachs Group Inc. have already exited similar businesses.

‘Important Clients’

Havens planned in 2010 to raise $3 billion over three years for CCA and outside investors already have put in $2.6 billion, he said.

Most of the external capital that CCA manages belongs to so-called ultra high-net-worth individuals, sovereign-wealth funds and pension and endowment funds, according to a Dec. 31, 2010, internal document obtained by Bloomberg News.

“They’re critically important clients for this company,” Havens said. “They’re the largest, most sophisticated pools of assets in the world.”

Havens declined to say whether Citigroup would keep any shareholder cash in the funds once the proposed rule, named for former Federal Reserve Chairman Paul Volcker, takes effect.

“We are a big believer in alternative asset management and we have huge faith in the management team at CCA,” Havens said. “I don’t put money in businesses I don’t like.”

--Editors: Peter Eichenbaum, Steve Dickson

To contact the reporters on this story: Donal Griffin in New York at dgriffin10@bloomberg.net; Katherine Burton in New York at kburton@bloomberg.net; Anthony Effinger in Portland at aeffinger@bloomberg.net

To contact the editors responsible for this story: David Scheer at dscheer@bloomberg.net; Christian Baumgaertel at cbaumgaertel@bloomberg.net; Michael Serrill at mserrill@bloomberg.net


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