Citadel Starts to Make Its Mark

The hedge fund administrator brings in $10 billion, but will it succeed in changing the business?

In July 2007, Chicago-based Citadel Investment Group launched a subsidiary, Citadel Solutions, aiming to shake up the hedge fund administration market with the same technological savvy that powers its own vaunted hedge funds. But as good as company executives thought their technology might be, they knew that success in the fiercely competitive world of transaction processing, performance reporting and other middle- and back-office support services would depend on overcoming other hedge funds’ natural resistance to handing revenue-generating business over to a competitor. Only one other hedge fund, Black River Asset Management, a subsidiary of agribusiness company Cargill, is currently offering these services to other funds, through its 2006 spin-off, LaCrosse Global Fund Services. Lacrosse Global’s $15 billion of assets under administration are a drop in the $2 trillion hedge fund ocean.

Citadel Solutions did its homework. Led by president John Buckley, hired from Lehman Brothers in 2006 to create the fund services arm, the firm interviewed nearly 40 hedge funds over six months to assess their needs and fears. As a result, the administrator set up separate offices — off-limits to Citadel hedge fund employees — and computer systems and turned to PricewaterhouseCoopers for independent audits. The tally so far: $10 billion in assets from 14 clients. But even with a total of $30 billion, including the $20 billion it administers for its parent firm, Citadel Solutions doesn’t crack the top 20 in the increasingly consolidated hedge fund administration market. Dublin-based Citco Fund Services, with more than $500 billion, leads the market, followed by affiliates of banking giants Fortis and HSBC Holdings, each with about $300 billion.

Undaunted, Buckley says, “We’re not in the business to be a bit player. We want to be in the top ten in five years, which would mean we would have to have well over $100 billion in assets. Shortly after that, we want to be No. 1 or No. 2.”

Citadel’s start is clearly modest, but its client wins include former Lehman Brothers securitization executive David Sherr’s One William Street Capital Management, which is launching two funds in the mortgage- and asset-backed market, and New York–based Knighthead Capital Management, started by Ara Cohen of Redwood Capital Management and Thomas Wagner of Goldman, Sachs & Co. The firm beat out Citco both times. “We’re proud to be competing out of the gate with the most progressive competitor,” says Buckley, who is also hoping to rope in new funds launched by established, multibillion-dollar firms.

Buckley has a potent sales pitch — Citadel’s technology is built “by a hedge fund for a hedge fund,” he says — that is taken lightly by no one, particularly such leading custodian banks as Bank of New York Mellon Corp., JPMorgan Chase & Co. and State Street Corp., which have acquired hedge fund administrators in recent years to offset slower growth in other parts of their businesses.

“The concept of taking a hedge fund platform, process and people and commercializing it is sound,” says Robert Caporale, head of JPMorgan Worldwide Securities Services’ private equity and hedge fund service business, which administers more than $100 billion for hedge funds. He notes that “we applied a similar approach in developing our alternative-investment services capabilities” with the February 2006 acquisition of the back- and middle-office operations of Greenwich, Connecticut, hedge fund Paloma Partners Management Co.

Custodians and others in the field see Citadel Solutions’ ties to its aggressive parent as a vulnerability. But David Zirin, chief operating officer of one-year-old, $1.4 billion-in-assets Pentwater Capital Management in Chicago, brushes off that concern. “Any provider could be whispering something. At some point you have to take a leap of faith,” says Zirin, who worked at Citadel in the 1990s. Pentwater vetted more than a dozen administrators before settling on Citadel. One initial concern: Citadel had to take off its “hedge fund hat” and pay closer attention to customer service. Buckley says that has been addressed through market research and the hiring of 20 client-services staff.

That was a must. Citadel Investment CEO Kenneth Griffin, who is reportedly planning to take his firm public, wants the steady revenues that transaction services provide. “Proprietary revenue streams will always have low P/E multiples,” says Buckley, “but an annuity revenue stream with high P/Es can generate meaningful returns.”

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