Hedge fund of the year: Citadel

The past 12 months at Citadel were nothing like previous years, but notable in a different way.

“In some years one of our businesses becomes a tall tree in performance terms, and in other years it’s the forest that thrives,” says the firm’s chief risk officer, Joanna Welsh. “And this has been one of those other years.”

In 2023, the hedge fund made much of its profit from its commodities business. In 2022, that same business, and Citadel’s fundamental equities unit stood out. In 2024, the contributions from different parts of the organisation were more evenly spread – exhibiting a healthiness across the firm’s business in a year that offered fewer fruitful trading opportunities for the industry.

Citadel’s flagship Kensington Wellington fund was up 11.2% for the year to November, according to people familiar with the matter. All five of the firm’s core strategies were positive. Returns across the industry as a whole averaged 7.4% over the same period, data from Hedge Fund Research shows.

The story in 2024, then, has been as much about what Citadel didn’t do as what it did. “Things that were a banana skin for people weren’t that way for us,” Welsh says. Citadel thinks hard “ex ante” about how positions are sized, she says, especially if those positions involve “stickier, longer-term pieces of risk or not the most liquid [instruments]”.

It has been a year of ups and downs in global markets, with a string of national elections adding to uncertainty. But Citadel has no “magic bullet”, Welsh says. “What’s worked for us is that we don’t get too concentrated in any one dimension, be it region, asset class, horizon, sector, or an outsized position in any one security.”

Citadel avoided the fallout from trading misses that afflicted the broader hedge fund community, such as rate curve steepener trades that failed to pay off and FX reversals. When markets convulsed sharply in the early days of August and popular carry trades unwound, for example, Citadel’s flagship fund finished the month in positive territory.

Citadel’s trick is partly to keep it simple. A managing director at one Citadel client praises Welsh for her practical approach in integrating risk into Citadel’s various teams and the firm’s culture, and for her plain speaking with portfolio managers and ability “not to get too academic”. The firm’s risk framework emphasises simplicity and transparency, he says.

Behind the curve

Citadel came into the year expecting “something of a hard landing” in the US, Welsh says. But its macro business adjusts quickly, and as the economy repeatedly beat expectations, Citadel’s portfolio managers reduced risk. “If there’s not much to do in macro, or we don’t feel like we’re seeing [opportunities] particularly clearly, we have other businesses,” Welsh says.

That wasn’t the case for everyone. Trades that would profit from central bank rate cuts were popular across the industry in early 2024, and for many proved to be a painful mistake. Sticky inflation and in some cases surprisingly strong employment numbers meant the first such cuts, from Canada’s central bank and the ECB, came later than expected, in June.

Steepener trades such as so-called 2s30s, for example – a bet that US two-year yields would fall faster than 30-year yields – traded at around -50 basis points in mid-January but moved in the wrong direction – to -83bp a month later.

Citadel’s portfolio managers were helped in navigating the erratic rates environment, Welsh says, by a more pragmatic way of thinking about curve risk the firm put in place in 2024. Rather than rely on principal component analysis – an abstract mathematical breakdown of what’s driving volatility in an investment – Citadel switched to describing its risks in terms of market observables: two-year or 10-year treasury yields, for example.

“In a year when curve trades have been popular, that gave us a way of isolating a very specific set of risk factors, rather than rely on generic statements like ‘curve risk’ when some people were in the short end and some people were in the long end,” Welsh says. The revised approach has the merit also of making clearer how portfolio managers should trade or hedge to adjust a given exposure.

Citadel has had a bias towards taking curve risk more than duration risk in several currencies since mid-year, Welsh says.

Carry on

Elsewhere, the Bank of Japan surprised markets with a rate hike in late July, triggering a rapid unwind of crowded yen carry trades. The resulting Asia equities selloff on August 5 in turn set in motion a record spike in the Cboe Vix index of implied volatility in US stocks.

The Wellington fund was up 1% for the month, however, according to the person familiar with the matter. And, again, Welsh attributes this partly to how the firm thinks about risks before the fact.

In FX carry, Citadel’s portfolio managers are expected as a matter of course to formulate – and share – a view on what could drive an unwind that would hurt their portfolio. In addition, Welsh’s team analyses the potential for more extreme tail moves across carry trades, and Citadel’s economists track macro drivers affecting the space.

That’s to say, Citadel was watching for just the sort of scenario that played out in the summer. “Together there are three different groups of people working to generate views of the volatility regime we’re in and where perturbations of that regime might come from,” Welsh says.

No firm can expect to consistently call the top or bottom of crowded trades, she says. But Citadel is looking always for “first mover advantage”.

“This is not about us having a crystal ball to predict the right time to exit.” But the firm makes sure to maintain an “open and transparent conversation” about crowding and momentum in such trades, she says.

‘The last mile’

The broad health of Citadel’s business aside, the firm’s youngest division – Global Quantitative Strategies – had an especially strong performance, and is on track for one of its best years yet. Citadel’s Tactical Trading fund, which is tilted towards GQS as well as fundamental equities, was up 18% year to date, Risk.net understands.

The unit’s disciplined approach to risk taking is the same familiar approach as elsewhere in the business. GQS works hard to carve out the precise part of an instrument’s returns that it can explain in terms of idiosyncratic drivers, and to determine whether these “dimensions” are predictable, says Navneet Arora, who heads GQS.

That said, Citadel has also had to react to what its competitors are doing. Performance this year in GQS was helped, Arora says, by improvements in how Citadel trades so as to avoid detection by high-frequency trading firms that have become increasingly active over the time horizons where quant investors traditionally operate. “You have to understand the last mile, how you take your trade to the market,” Arora says. “The old-fashioned quantitative investing process was that you made good predictions, and you did your risk management, and you were off to the races. The landscape has shifted.”

High-frequency trading firms are now “playing in an area that traditionally only long-horizon firms used to play in”, Arora says, starting to hold positions for maximum times longer than just a few minutes, meaning their algorithms potentially can detect and trade against a systematic player like Citadel. “You have to be aware of, and understand, whether you may or may not be leaving footprints,” he says.

Tail blazer

Thinking about tail risks is a foundational principle at Citadel, not least because of CEO Ken Griffin’s experiences in past drawdowns. Citadel was rumoured to be close to collapse in 2008 but survived and rebounded to make returns of more than 60% the following year. The firm famously tracks its risks real-time on floor-to-ceiling screens, a second installation of which is now under construction in the New York office.

In fundamental equities this year, Citadel steered away from the tech names driving US markets higher. “Portfolio managers are not allowed to gravitate towards the most popular stocks, the things that are making the news,” Welsh says. “The Mag Seven is not something we will be discussing at our portfolio level because we just don’t have that type of concentration.”

No episode of stress passes without close examination, says the client’s managing director. “A lot of firms spend a lot of time looking at why they’re losing money,” he says. Welsh’s team goes further, asking questions even when the firm is making money, with a view to gaining a comprehensive understanding of how and why.

The consistency of performance at Citadel has made it the most profitable hedge fund of all time, according to a ranking from LCH Investments. Kensington Wellington returned more than 19% annualised from its inception to the end of 2023, according to the person familiar with the matter.

It’s a long track record. And in 2024 – a year without tall trees – Citadel showed it continues to be in verdant health.