How Citadel used the weather to claim the hedge fund crown

In 2018, Ken Griffin’s Citadel hired a group of scientists and analysts whose weather forecasts were more accurate than most meteorological agencies.

The hiring of the 20-person team was unusual for a large hedge fund in an industry largely focused on equities, bonds and currencies. But it was a key part of Griffin’s $54 billion company’s effort to build a broad commodities business that spans futures as well as physical trading.

The bold bet on commodities has paid off, helping Citadel earn a record $16 billion by 2022 to displace Bridgewater as the most successful hedge fund of all time, according to research from LCH Investments.

As the historically subdued gas market came alive during the lifting of the Covid lockdowns and the Russian invasion of Ukraine, Citadel was perfectly positioned to reap billions of dollars in trading profits.

“Citadel is very strong in gas and power,” said Pierre Andurand, founder of hedge fund Andurand Capital and one of the world’s top energy traders. “They work a lot on supply and demand. They take big bets and hold onto them for months.”

Even by the standards of the hedge fund industry, Citadel is secretive. Investors say privately that it has long been difficult to get details about the company’s transactions, while the company’s investor communications, compared to many hedge funds, provide relatively little information.

A spokesperson said the company is holding hundreds of one-on-one investor meetings and investor calls.

Such a large exposure to commodities has given Citadel an edge over rivals in recent years, according to people familiar with the company who said its flagship funds can manage a quarter or more of their total commodities portfolios.

“Citadel’s institutional energy trading and commodities operation was certainly a big asset to their eye-popping year,” said Jim Neumann, chief investment officer at Sussex Partners, which advises clients on hedge fund investments.

Most of the company’s rivals have not built up to the same extent in commodities, as the sector presented less attractive opportunities than stocks or bonds for so long pre-pandemic, especially when adjusted for the risk of major losses.

Many, including Brevan Howard, Astenbeck Capital and Armajaro, have even closed commodity funds over the past decade against the backdrop of wild price swings and extended periods of price decline. Most now have only a single-digit percentage of their wealth in commodities exposure, if at all.

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Citadel got into the commodities business in 2002, hiring a group of former Enron traders.

According to investor documentation reviewed by the Financial Times, exposure is significantly higher than a decade ago, so when commodity prices start to move, it could gain a significant advantage over rivals. It made billions of dollars in 2021 just betting on gas and power, say people close to the company.

Last year proved even more lucrative as Russia’s attack on Ukraine sent markets into panic over sanctions and energy shortages. The volatility – with prices rising first in March and hitting another all-time high in August – presented a wealth of trading opportunities.

The team of European head of gas trading Chris Foster, who is known for spirited bets, has helped generate billions of dollars for the fund, according to people familiar with the company who say Citadel raised $7 billion to $8 billion last year. billion in raw materials. .

Griffin and his senior team are attracted by the size of the asset class, its low correlation to other markets and its complexity. In gas, the supply can be mapped and analyzed by its large teams of researchers, while the many gas hubs in the US and abroad offer numerous prices that can be traded.

Forecasting demand is much more difficult. Weather has a major influence on usage, which is higher during hot summers due to air conditioners and in cold winters when homes are heated.

This is where Citadel is seen as a key asset, with its traders receiving information from a weather team that uses supercomputers to make forecasts and includes specialists in areas such as thunderstorms and tropical cyclone forecasts. Much of the team is based in London, well placed to take advantage of volatile European gas and electricity prices.

It has been strengthened in recent years with recruitment from academia. Weatherhead Nicholas Klingaman, formerly of the UK’s National Center for Atmospheric Science, specializes in ‘sub-seasonal forecasting’. Such forecasts, usually up to two months ahead, are much more difficult than shorter-term forecasts and very lucrative if accurate.

Citadel’s physical commodities business – which trades the commodities and is led by former Morgan Stanley head of commodities trading Jay Rubenstein – traded more than 1.1 trillion cubic feet of gas in 2021 and is now a major physical gas player in the US.

Citadel’s profits from gas and other commodities played a major role in its record performance of 38.2 percent last year, bringing its annualized return since its launch in 1990 to 19.7 percent. About 70 percent of Citadel’s investors are institutions, including universities and pension funds.

“It is clear that 38 percent per year is unsustainable,” said Andrew Beer, a managing member at US investment firm Dynamic Beta. “On the other hand, if you have the best information, the smartest people, the capital locked up, and almost unlimited Wall Street borrowing capacity, why not try shooting the lights out?”

A Citadel spokesperson said: “Unlike our competitors, Citadel’s resources team invests globally in a diversified range of products. . . leveraging more than 20 years of long-term, steady investment in exceptional people, analytics and infrastructure.”

There are signs that rivals want to join in. Balyasny hired a tropical weather specialist and an ocean warming expert last year.

Last year was a strong year for many Citadel colleagues. Millennium Management, DE Shaw, Balyasny and Point72 all posted double-digit gains, while many equity funds were hit by the slump in technology stocks. Multi-strategy funds last year achieved their highest level of “alpha” — industry jargon for profit above and outside the market — since the aftermath of the 2009 financial crisis, according to JPMorgan research.

“If you relied less on long-short equity and had more access to other assets, you had a better chance,” Neumann said.

But industry insiders say Citadel did so well not only because of its diversification across assets offering some of its best trades in years, but also because of the size of the bets, encouraging traders to take positions in instead of sitting on the sidelines.

“You feel like you always have to be risky, there’s constant pressure from above,” said a person with knowledge of the company.

A Citadel spokesperson said its investors “entrust us and expect us to commit their capital to the investment opportunities we see in the market.”

Griffin gets to know his managers’ trades inside out and will allow more risk to be assigned to a position when he sees a particularly attractive opportunity to make a profit.

The company also has a strong presence in fixed income and macro, an industry that posted its best gains since the financial crisis last year, when government bond yields and the dollar soared as central banks scrambled to contain rising inflation.

The fixed income and macro fund, which makes both directional and arbitrage bets, earned 32.6 percent, beating many specialized macro funds. The company posted record years in four of its five business areas: commodities, fixed income, equities and quantitative strategies.

“Inflation trading was the subprime of 2022,” said Dynamic Beta’s Beer. “Like the big winners back then, Citadel went all in and pushed his bet far more than some of his peers.” A person close to the company said it had a diversified set of strategies across fixed income and macros, all of which performed well.

However, some industry insiders believe that the size of the bets that multi-manager funds make can leave them vulnerable to extreme market events.

“The transparency in these high-end companies is not great and it is recognized that given the level of leverage, there is significant risk to Black Swan events,” said Neumann. “Confidence that central banks will provide relief to mitigate such a shock. . . is embedded in the investment decision.”

A person close to the company disputed that this assessment applied to Citadel, pointing out that the hedge fund raised $2 billion from investors in March 2020 as the coronavirus pandemic rocked markets.

Griffin has attributed the company’s recent success to its return to the office early in the coronavirus pandemic. Industry insiders also attribute it to the size of Citadel, which can provide top traders with a larger book to manage on day one, increasing potential payouts.

The traders and analysts are now ready to enjoy a great payday. Last year, Citadel charged $12 billion in expenses and fees to its customers — more than one-fifth of whom are employees — driven by the need to reward merchants who performed well.

Bonuses at the company, announced to staff in late January with payments made last month, ran into the tens of millions of dollars for some traders. Expectations are for even bigger amounts this year, with some star teams expecting payouts in excess of $100 million.

The fees are “astronomical,” said one investor, but without them, companies like Citadel “can’t compete for talent.”

Additional reporting by Robin Wigglesworth and George Steer






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