(Bloomberg) -- Citadel employees’ investment in its $45 billion flagship hedge fund surged during the past several years, driven by robust returns and lockups that the firm imposes on a big chunk of their annual compensation.
The assets held by principals and staff in the Citadel Wellington fund jumped to 20% as of Dec. 31 from 12% at the end of 2019, filings show. In dollar terms, the value of their combined stake, including that of founder Ken Griffin, more than tripled to about $9 billion during that span.
The figures offer a rare glimpse into how Citadel is balancing divvying up the spoils of a stellar investing run and retaining the portfolio managers that produced it. Much of the increase in the employee share is attributable to the performance of Wellington, which generated annualized returns of 25.9%. That resulted in higher payouts for Citadel traders and portfolio managers, who are required to leave roughly half of their incentive awards, over a hurdle, in the fund for 3 1/2 years.
“Citadel’s principals and employees have invested in our funds for over 30 years,” Ed O’Reilly, head of the firm’s client and partner group, said in a statement. “Our alignment of interests with our external capital partners is a powerful statement about our commitment to building a lasting franchise.”
But there’s also a downside for investors — even if it’s a high-class problem. Given that some of Citadel’s funds can handle only so much capital before performance begins to wane, the firm has returned profits to investors each year for decades, including $6 billion from Wellington for 2023 alone, according to an April report by Kroll Bond Rating Agency. That left the flagship fund with $44.8 billion at the start of this year.
In contrast, profits on employees’ deferred compensation generally remain invested until their lockups expire — a big advantage during the past four years.
While some investors may welcome the returned cash, others might prefer to leave their money in Citadel’s flagship fund.
“Once the capital is returned from a very successful fund, you have to find another home for it,” said Keith Danko, managing member of Witherspoon Partners, a Princeton, New Jersey-based consulting firm that advises hedge funds and investors. “And it might be difficult to find a home that provides the same high returns.”
In addition to deferred pay, Citadel has vehicles for principals to make voluntary investments in its funds once their compensation reaches a certain threshold. During the past five years, the assets in two of these vehicles, CEIF and CEIF Partners, have more than doubled to about $5 billion, according to documents filed each May. Citadel employees pay the same fees on their invested cash as external clients.
Griffin, 56, is the largest single investor in Wellington. His stake in Citadel Advisors, the firm’s money-management arm, and its funds account for almost half of his $41.8 billion fortune, according to the Bloomberg Billionaires Index.
Citadel’s four funds —- Wellington along with Equities, Global Fixed Income and Tactical Trading — have been distributing some or all of their annual profits to clients since 1999, including $25 billion since 2017.
Traditionally, cash rebates have most often come from quant funds that rely on computer-driven strategies to guide their trading, said Joe Marenda, head of hedge fund research and digital assets investing at Cambridge Associates. Multistrats generally hadn’t returned much cash, Marenda said, because they have the flexibility to quickly redeploy capital to trades that are producing the biggest gains.
Yet Izzy Englander’s Millennium Management has returned billions of dollars in capital in recent years – part of a plan to push clients into funds with longer lockups — and Steve Cohen’s Point72 Asset Management is preparing to give back capital for the first time.
In determining the amount of annual profit to return to clients, Citadel factors in the amount of growth its funds have recorded in the prior year as well as the opportunities and capacity it expects for the coming one, people familiar with the matter said.
“We appreciate the integrity it takes to acknowledge” that a fund has more money than it needs, said Michael Rosen, chief investment officer at Angeles Investment Advisors, speaking generally. “There’s a strong financial incentive to hold onto capital because you get to charge fees on it.”
The increased employee stake at Wellington mirrors a broader change in the firm’s capital base that has been underway for years. Citadel has sought to replace money invested by funds of funds with capital drawn from institutional investors, including mission-driven organizations such as charities and universities.
For the firm as a whole, institutional cash peaked at 60% of net assets at the end of 2021, up from 41% five years earlier, while funds of funds declined to 9% from 32%.
Since then, employees have accounted for the largest change in the firm’s investor base, rising to 29% of total assets at the end of June from 21% at the end of 2021. Meanwhile, institutions’ share of overall assets slid from its peak to 54% at midyear.
While institutions comprise a smaller percentage of Citadel’s total assets, the value of their holdings has continued to increase. That’s because the firm itself has grown, with net assets under management climbing to $64 billion as of Oct. 1 from $43 billion at the end of 2021.
The increase in deferred compensation makes it more difficult — or at least more expensive — for rivals to poach Citadel traders and portfolio managers. In the hedge fund business, employers typically must make recruits whole for the deferred pay they forfeit when leaving their previous jobs.
“It’s getting more challenging and complex, as well as more expensive, but that doesn’t mean money managers won’t do it for the right talent,” said Jason Schulman, a partner at Long Ridge Partners, a recruiter for private equity and hedge funds. “That said, there needs to be more of a real reason for someone wanting to move than just a big check.”
--With assistance from Katherine Burton and Tom Maloney.
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