Citadel And Its Peers Are Piling Into the Same Trades. Regulators Are Taking Notice



Even Ken Griffin is a little worried.


Multimanager funds like Griffin’s Citadel have come to dominate the hedge fund industry, riding a steady run of outperformance to oversee more than $1 trillion, including a healthy dose of leverage. But the explosive growth has led the industry giants to pile into many of the same trades.


That has built unease among regulators, investors and traders over these so-called pod shops. And while Citadel’s billionaire founder has vocally opposed any notion that his firm and rivals pose systemic risks and need more regulation, even he acknowledges that crowded trades could lead to widespread losses if all of them head for the exits at once.


“Could you see the multimanager hedge funds take a joint 10, 15, 20% hit to their equity? It’s possible,” Griffin said during a Nov. 9 interview at a Bloomberg conference in Singapore, calling such a drop “painful, but not systemic.”


Citadel, Millennium Management and Balyasny Asset Management are the leaders in a strategy that divvies up money across dozens or even hundreds of teams that operate somewhat independently across a range of markets and strategies.


Their success in the past several years has drawn new investors and competitors. Yet overcrowding in some bets, increased market volatility, an expensive talent war and lower returns this year have prompted market participants to question whether the world of high finance is approaching peak pod.


Officials at the Securities and Exchange Commission and US Treasury Department have warned that the firms’ favored basis trade could destabilize Treasury markets. At least one large bank is approaching the limit of how much it’s willing to lend to them, and some investors are growing more wary.


“There’s some overcrowding and concern about the amount of leverage at individual firms and collectively,” John Jackson, head of hedge fund research at investment consultant Mercer, said during a recent Capital Allocators podcast. And because they typically cut risk very quickly “we are worried about the potential snowball effect.”


Some investors are capping the amount of money they allocate to these funds, fearing blowups. Others are avoiding newer entrants, saying they could be hurt the most by a big unwinding. Smaller hedge funds, meanwhile, are looking for ways to profit from the market dislocations these larger competitors create.


It all amounts to a fault line in what has been a largely envied corner of the hedge fund universe — where pod shops have attracted more assets and star talent, driven up compensation and generated years of steady returns for investors.