Wednesday, May 07, 2008

Distrust, Hedge Funds & Citigroup

It's been a rough month for Citigroup's asset management groups.

In last Tuesday's Wall Street Journal, the bank's missteps with its Falcon and ASTA/MAT hedge funds were detailed. Rather than holding low risk securities for its investors, these two Citigroup funds actually held instruments which were savaged by the recent credit crunch.

According to the Journal article, the Falcon hedge funds lost about 80 cents on the dollar for investors, who are being offered between 45 and 54 cents on the dollar, if they promise not to sue the bank.

Moreover, only aggressive lobbying on behalf of the loss-plagued customers by Sallie Krawcheck brought the settlement offer to life. Other executives at Citigroup were willing to let their customers take the entire loss, despite the bank's probably misrepresentation of the hedge funds as being less risky than they in fact were.

Citi will spend about $250MM in payments to customers to partially compensate them for losses and allow them to exit the funds.

As if that isn't bad enough for the sprawling, mismanaged finanicial titan, this weekend's Wall Street Journal disclosed that nearly all outside investors in the bank's Old Lane hedge fund, which it purchased from Vikram Pandit and his partner John Havens. According to Jenny Strasburg's article entitled "Citigroup Lets Investors Bail From Old Lane,"

"In March, Citigroup gave Old Lane's outside investors, who have claims on about $3 billion of the fund's money, permission to withdraw early as a result of changes in the fund's senior management. The biggest: Old Lane co-founder Vikram Pandit became Citigroup's chief executive in December. John Havens, another co-founder, now runs Citigroup's investment bank.

According to a securities filing made Friday, "substantially all unaffiliated investors" -- meaning those who didn't help run Old Lane or work at Citigroup -- notified the bank they wanted out. The exodus will drain about $3 billion from Old Lane, according to people familiar with the fund. Investors have to wait until July 31 to get their money back."

Chalk up another shrewd move by non-executive Citigroup Chairman Bob Rubin, adding further luster to the record I described in this recent post. According to Ms. Strasburg, the ugly details of Rubin's hedge fund bet gone wrong include,

"After paying an estimated $800 million to acquire the hedge fund and bring in its management team last year, Citigroup last month wrote down the value of Old Lane by $202 million. Mr. Pandit got $165.2 million on a pretax basis from selling Old Lane to Citigroup, according to a securities filing in March.

Amid a string of hedge-fund blowups, Old Lane's returns weren't a disaster. But there wasn't much lure for investors to stick around. The multistrategy fund's returns are about flat since its 2006 inception, according to an investor. Founders boasted early on about raising $4 billion in less than nine months but gained little momentum after that.

In September, Citigroup closed its $2 billion Tribeca Global Investments LLC with plans to market Old Lane to bank clients as the company's flagship hedge fund. Those plans were scuttled."

This will result in Citigroup losing some $3B in assets which will be withdrawn from Old Lane, as it closes down.

Much as I prophesied in this post last year, Rubin made a colossal blunder which benefited the inexperienced hedge fund manager-cum-Citigroup CEO, Pandit. As I lampooned in that post about a fictional interview with the new Citigroup CEO,

"Pandit: And by asking me to head up alternative investments, I was able to shed any direct responsibility for Old Lane as soon as I had my picture laminated onto that Citi ID badge. Whew!

Talk about a tough business! In hedge funds, you have to perform. Back at Morgan Stanley, I always had lieutenants, or the market, or competition to blame if any of the areas under me messed up. But with a hedge fund, you're only as good as your last returns. And Old Lane's have really disappointed pretty much everybody."

Sadly, this has come true in spades. Now the original reason for bringing the ex Morgan Stanley investment banker into Citigroup has been totally discredited as an expensive mistake. What remains is Pandit's elevation into a job for which he has no obvious credentials or experience.

With management behavior like this at Citigroup- steering valued customers into too-risky hedge funds, arguing internally over compensating those customers for their losses due to the bank's misrepresentation of the funds, and buying a mediocre, untested hedge fund which has closed within two years of the purchase- its customers must wonder if the bank ever considers their long term needs and welfare.

All in all, not a good pair of outcomes for a bank in trouble across so many of its businesses.

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