Citigroup Inc. is profiting from a hedge fund that bets the company's money on mortgage debt, which regulators plan to restrict.
Citigroup's Mortgage/Credit Opportunity Fund climbed 16% in the first four months of 2011, almost doubling its pace last year, according to internal reports obtained by Bloomberg. About 90% of the $395 million invested in the fund is the company's own capital, said a person with direct knowledge of the matter.
The fund, run by Rajesh Kumar, has posted profits every year since it began in 2008, letting the New York company benefit from an asset class that almost caused its collapse. Citi may seek new investors for the vehicle before regulators implement the Volcker Rule, which Congress passed last year to force banking companies to cease bets with their own money.
"If the Volcker Rule gets defined the way it was originally intended … then they're probably going to need to divest their interest," said Charles Whitehead, an associate professor of law at Cornell Law School in New York. "Why kill the goose before you have to?"
Citigroup, led by CEO Vikram Pandit, a former hedge fund manager, invested the initial $200 million when Kumar started the fund. Kumar joined Citi in 2008 from Halcyon Asset Management LLC.
Kumar oversees investments for Citi in commercial and residential mortgage bonds, including those tied to subprime loans. His team also bets company money on real estate investment trusts, government bonds and derivatives, internal reports show.
The fund returned 17% for the eight months of 2008 after its launch, 23% in 2009 and 26% last year, according to the documents, which include estimates for this year's performance. Annualized, the 2011 return through April was about 47%.
"We remain bullish on the growth prospects of the overall U.S. economy and on the commercial real estate sector in particular," Kumar wrote in a March report. "Mortgage product looks like a great relative value!"
Hedge funds worldwide have gained 3.5% this year through April. Those that are focused on fixed-income products rose 3.2%, according to May 11 estimates by HedgeFund.net. Last year, the HFRI Weighted Composite Index, which tracks the performance of more than 2,000 hedge funds that manage at least $50 million, climbed 10%.
Kumar's fund is part of Citi Capital Advisors, which oversees $16 billion in alternative funds, including private-equity and venture capital funds, according to a person familiar with the matter.
The division, led by Jonathan Dorfman and James O'Brien, manages $5 billion of Citi's own money, said the person, who spoke on condition of anonymity because the figures are not public.
The Mortgage/Credit fund is outpacing Citigroup investment vehicles including the Event Driven Fund. That fund gained about 7.1% this year through April, according to estimates in the internal reports. The Emerging Markets Special Opportunities Fund is up 4.2%, the records show.
The Global Macro Fund fell 6.9% this year through April, according to estimates. Managers of macro funds seek to gain from global trends, and the Global Macro Fund uses "nimble" strategies to bet on government bond and currency markets, according to Citi's website. Macro funds have gained 2.8% through April, data compiled by Bloomberg shows.
The documents do not list any of the funds' sizes or indicate what share of their capital belongs to the bank. An April 2010 marketing brochure for the Event Driven Fund said that it "consists of only proprietary capital."
Danielle Romero-Apsilos, a Citi spokeswoman, did not comment on the funds' performance.
Citi posted losses totaling almost $30 billion for 2008 and 2009, much of it tied to subprime mortgages. It repaid the funds last year, giving the Treasury Department a profit of about $12 billion.
Kumar's team separately managed two collateralized debt obligations tied to subprime bonds that were liquidated in 2008 and 2009, and "have lost most of their economic value," according to the April 2010 brochure. CDOs package assets such as mortgage bonds into new securities with varying risks.
