In 2018, Ken Griffin’s Citadel hired a group of scientists and analysts whose weather forecasts were more accurate than most weather bureaus.
Hiring the 20-person team was unusual for a large hedge fund in an industry largely focused on stocks, bonds and currencies. But it has been a key part of efforts by Griffin’s $54 billion asset company to build a broad commodities business encompassing both futures and physical trading.
The bold commodity bet paid off, helping Citadel achieve a record $16 billion in 2022 to supplant Bridgewater as the best-performing hedge fund of all time, according to research by LCH Investments.
When the historically subdued gas market exploded amid the lifting of Covid lockdowns and then Russia’s invasion of Ukraine, Citadel was perfectly positioned to reap billions of dollars in trading profits.
“Citadel is very strong in gas and electricity,” said Pierre Andurand, founder of hedge fund Andurand Capital and one of the world’s leading energy traders. “They work a lot on supply and demand. They take big bets and keep them for months.
Even by hedge fund industry standards, Citadel is secretive. Investors say privately that it has long been difficult to obtain details of the company’s transactions when, compared to many hedge funds, the company’s investor communications give relatively little information.
A spokesperson said the company held hundreds of one-on-one meetings with investors and held investor calls.
Having such 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 overall portfolios in the raw materials.
“Citadel’s institutional energy and commodities trading operation has certainly been a big boost to their blistering year,” said Jim Neumann, chief investment officer at Sussex Partners, which advises clients on fund investments. speculative.
Most of the firm’s rivals have not developed commodities to the same extent given that the sector offered less attractive opportunities than stocks or bonds for so long before the pandemic, especially when adjusted for the risk of large losses.
Many, including Brevan Howard, Astenbeck Capital and Armajaro, have even closed commodity funds over the past decade amid sharp price swings and long periods of price declines. Most now only have commodity exposure of a single-digit percentage of their assets, if at all.
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Citadel entered the commodities business in 2002, hiring a group of former Enron traders.
Its exposure is significantly higher than it was a decade ago, according to investor literature seen by the Financial Times, so when commodity prices start to move, it can gain a big advantage over its rivals. It raked in billions of dollars in 2021 just by betting on gas and electricity, say people close to the company.
Last year proved even more lucrative as Russia’s attack on Ukraine sent markets panicking over sanctions and energy shortages. The volatility – with prices first peaking in March and again at an all-time high in August – provided a wealth of trading opportunities.
European gas trading executive Chris Foster’s team, which has a reputation for making hard-hitting bets, has helped generate billions of dollars for the fund, according to people familiar with the business, who say Citadel won $7-8 billion from raw materials last year.
Griffin and his senior team are drawn to the size of the asset class, its low correlation to other markets and its complexity. In gas, supply can be mapped and analyzed by its large teams of researchers while the many gas hubs across the United States and beyond offer plenty of prices that can be traded.
Demand forecasting is much more difficult. Weather strongly influences usage, which is higher in hot summers due to air conditioners and in cold winters when homes are heated.
This is where Citadel is seen to have a key advantage, with its traders fed information by a weather team that uses supercomputers to run forecasts and includes specialists in areas such as storm and tropical cyclone forecasting. A large part of the team is based in London, well placed to take advantage of the volatility of gas and electricity prices in Europe.
It has been strengthened in recent years with hiring outside academia. Weather chief Nicholas Klingaman, formerly at the UK’s National Center for Atmospheric Science, specializes in “sub-seasonal” forecasts. Such forecasts, usually up to two months in advance, are much more difficult than short-term forecasts and very lucrative if accurate.
Citadel’s physical commodities business – which trades commodities and is led by former Morgan Stanley commodities trading head Jay Rubenstein – traded more than 1.1 tonnes of cubic feet of gas in 2021 and is now a major physical gas player in the United States.
Citadel’s earnings from gas and other commodities played a big role in its record performance of 38.2% last year, which took its annualized return since its launch in 1990 to 19.7%. Approximately 70% of Citadel’s investors are institutions, including universities and pension plans.
“Clearly 38% a year is not sustainable,” said Andrew Beer, managing member of US investment firm Dynamic Beta. “On the other hand, if you have the best information, the smartest people, locked-in capital, and almost unlimited borrowing power on Wall Street, why not try turning off the lights?”
A Citadel spokesperson said, “Unlike our competitors, the Citadel Commodities team invests globally in a diverse set of products. . . built on more than 20 years of consistent, long-term investment in exceptional people, analytics and infrastructure.”
There are signs the rivals want in on the act. Balyasny last year hired a tropical weather specialist and an ocean warming expert.
Last year was a strong one for many Citadel peers. Millennium Management, DE Shaw, Balyasny and Point72 all posted double-digit gains, although many equity funds were hurt by the drop in tech stocks. Last year, multi-strategy funds hit their highest level of ‘alpha’ – industry jargon for profits beyond the market – since the aftermath of the 2009 financial crisis, research shows. from JPMorgan.
“If you were less dependent on long-short stocks and had more access to other assets, you had a better chance,” Neumann said.
But industry insiders say Citadel has done so well not just because of its diversification among assets offering some of the best trades in years, but also because of its betting size, with traders encouraged to manage positions rather than standing aside in cash.
“You feel like you always have to take risks, there’s constant pressure from the top,” said a person familiar with the company.
A Citadel spokesperson said its investors “trust us and expect us to deploy their capital based on the investment opportunities we identify in the market.”
Griffin gets to know his managers’ trades inside out and will allocate more risk to a position when he sees a particularly attractive profit opportunity.
The company also has a strong presence in fixed income and macro, a sector that posted its best gains since the financial crisis last year as government bond yields and the dollar soared amid that central banks were rushing to bring soaring inflation under control.
Its bond and macro fund, which makes both directional and arbitrage bets, returned 32.6%, beating many specialized macro funds. The firm had record years in four of its five business areas – commodities, fixed income, equities and quantitative strategies.
“Inflation trading was the subprime of 2022,” Dynamic Beta’s Beer said. “Like big winners back then, Citadel went all out and pushed their bet far more than some of their peers.” A person familiar with the company said it had a diverse set of fixed income and macro strategies, all of which performed well.
However, some industry insiders believe that the size of the bets taken by multi-manager funds can make them vulnerable to extreme market events.
“The transparency in these sophisticated businesses is not great and it is recognized that there is substantial risk, given the level of leverage, for black swan events,” Neumann said. “Confidence that central banks will provide relief to mitigate such a shock. . . is integrated into 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 threw markets into turmoil.
Griffin attributed the company’s recent success to returning to the office at the start of the coronavirus pandemic. Industry insiders also attribute it to Citadel’s size, which can offer top traders a bigger book to handle on day one, increasing potential earnings.
Its traders and analysts are now ready to take advantage of an exceptional salary. Last year, Citadel billed $12 billion in expenses and fees to its customers — more than a fifth of whom are employees — driven by the need to reward merchants who performed well.
The company’s bonuses, announced to staff in late January with payments made last month, were in the tens of millions of dollars for some traders. Expectations are for even bigger numbers this year, with some star teams set to receive payouts of over $100 million.
The fees are “astronomical”, said one investor – but without them companies like Citadel “cannot compete for talent”.
Additional reporting by Robin Wigglesworth and George Steer
laurence.fletcher@ft.com