Hedge Fund Sowood Suffers 50% Loss, Plans to Wind Down

Hedge fund Sowood Capital told investors on Monday that it would shut down after losing half of its assets on soured bond market bets, becoming the first-high profile fund forced out of business by recent market turmoil.

The Boston-based fund, which managed money for Harvard University and other prominent clients, saw assets dwindle to roughly $1.5 billion from $3.0 billion in less than four weeks.

Its Sowood Alpha Fund Ltd declined approximately 57% during the month, while the Sowood Alpha Fund LP dropped approximately 53%, fund manager Jeff Larson wrote to clients late on Monday.

Speculation spread through bond markets on Friday that a Boston-based fund was in deep trouble, but by week's end, a person familiar with Sowood's operations said it had lost 8% in July and had met its margin calls.

That message clearly changed over the weekend when Larson, who had launched the fund with great fanfare in 2004, decided the only way out was to transfer a portion of the portfolio to Citadel Investments Group, a hedge fund with roughly $14 billion in assets under management.

"Citadel offered the only immediate and comprehensive solution," Larson wrote to clients. Citadel rescued failed hedge fund Amaranth Advisors' energy portfolio last year.

Larson blamed the fund's severe and sudden losses on sharply wider credit spreads for companies' debt that came without a corresponding move in equity prices and was exacerbated by a marked decline in liquidity.

The fund manager wrote movements, which had been manageable until last week, spiraled out of control at the end of the week when "counterparties began to severely mark down the value of the collateral that had been posted by the funds."

Telling investors that he is very sorry for the losses, Larson wrote "in the interest of preserving our investors' capital, the appropriate course of action was to sell the funds' portfolio".

A copy of the letter was obtained by Reuters on Monday.

No terms were announced for the deal between Sowood and Citadel, but hedge fund managers speculated the transaction was worth hundreds of millions of dollars.

Larson promised to meet investors individually but warned it will take his team "a few days to organize everything in a manner that will satisfy your questions."

On Monday evening, no one at the fund could say how much money Larson had lost for Harvard, which had entrusted part of its $30 billion endowment to Sowood.

Since quitting Harvard's in-house money management arm where he earned a millions of dollars in salary for overseeing foreign equities, Larson kept a low profile even by hedge fund industry standards. He never reported his performance numbers to industry trackers and rarely said anything about the fund.

But Larson's Harvard pedigree coupled with strong risk controls impressed many and let him raise roughly $3 billion very quickly, several people who know him said.

Rumors that Sowood might be forced to liquidate unnerved bond markets on Friday as hedge fund managers and traders feared a collapse might prompt investors in other funds to demand their money back too.

Citadel's move on Monday calmed some nerves and indicates liquidity is still available with buyers standing on the sidelines ready to move in to snap up beaten down portfolios.

"This transaction provides for an orderly transference of risk between the parties," Citadel's founder and chief executive Ken Griffin said in a statement.

Outsiders said that, even though Citadel moved in, investors likely suffered hard. "I don't think anyone was bailed out here," said Jim Midanek, whose hedge fund firm, Black Pearl Asset Management, plans to buy cheap subprime mortgage securities battered by the current crisis.

Sowood's troubles follow on the heels of news two large Bear Stearns funds had essentially lost all of their capital in the subprime mortgage market.

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