Citadel's Rise to Immortality
Inside the firm's intense risk management and technology
In 2008, Citadel’s two main funds lost 55% of their value.
55%!
Citadel’s flagship funds, Kensington and Wellington, were heavily exposed to convertible bonds. Unsurprisingly, Ken Griffin, Citadel’s CEO, started his trading career in exactly the convertible bonds space. He famously convinced Harvard to let him install a satellite dish on his dormitory, so he could trade from his room. He ran a convertible bond arbitrage fund while studying.
The market for convertible bonds crashed following the collapse of Lehman Brothers in September 2008. Citadel’s heavy exposure to convertible bonds led to major losses for their convertible positions. The losses were severely exacerbated by the high leverage the firm had taken on.
Times were dark and things kept getting worse. Investors asked to withdraw $1.5 billion in assets from Citadel's flagship funds.
The firm was rumoured to be close to collapse. Former employees even recall that Ken Griffin was inches away from closing the firm. Ken Griffin describes it as his “low point”. Citadel bounced back the following year, delivering 62% net returns, and hasn’t looked back since.
What Citadel experienced in 2008 unfolded over the next decade and a half, arguably turning it into the most formidable force in the hedge fund world, or as it says at the elevator doors at its new Miami HQ:
“#1 Most Profitable Hedge Fund Manager of All Time”.
Perhaps deservingly so. Some estimates show that on an absolute basis, Citadel, the hedge fund, and Citadel Securities, the trading firm, have made more money than anyone else in the history of the capital markets.
In a tough 2022 for the hedge fund industry, Citadel made $16 billion for its investors - the largest annual gain EVER made by a hedge fund firm - surpassing Bridgewater Associates in being the top alternative money manager by net gains since inception, per LCH Investments’ rankings. It is estimated that Citadel has generated roughly $74 billion in total gains since 1990. In the first quarter of 2024 alone, Citadel Securities’ revenue reached $2.3 billion, marking a 68% y/y growth.
Many suffer the consequences of their mistakes, but few learn from them.
What almost killed Citadel in 2008 is precisely what makes it the best hedge fund in the world today: exposure.
In this write-up, we cover Citadel’s big competitive advantage in identifying idiosyncratic winners and losers, why attribution of risk numbers matter as much as the numbers themselves, and the importance of idiosyncratic variance in generating alpha on the long and the short side. We also explain the collapse of cash bond prices at the start of Covid, how that led to Citadel’s portfolio and risk team to develop a new factor, the concept of risk limits, and more.