Ex-Citadel Trader Sethi Said to Start Volatility Hedge Fund
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By Jeff Kearns and Saijel Kishan

March 24 (Bloomberg) — Pav Sethi, former global head of volatility arbitrage at Citadel Investment Group LLC, plans to start his own hedge fund, according to a person familiar with the matter.

Sethi’s Gladius Investment Group will begin trading by June, according to the person, who asked not to be identified because the information is private. Jennifer Hoffman, counsel for the Chicago-based firm, declined to comment.

Volatility funds, which make bets that prices of different options or securities will converge or diverge, returned 4.3 percent last year, according to the Newedge Volatility Trading Index. That compared with an industry average loss of 19 percent, according to Chicago-based Hedge Fund Research.

“The environment is not great for raising money, but volatility funds are one of the places that funds of funds are wanting to invest,” said Karim Leguel, New York-based chief investment officer at Rasini & C. Ltd., which advises clients on investing in hedge funds. “However, their returns are cyclical, and many funds don’t survive when volatility falls.”

About 659 hedge funds started last year, the fewest since 2000, when 328 funds were set up, according to Hedge Fund Research Inc.

Joining the 36-year-old Sethi will be former Citadel portfolio managers Rajesh Kedia, 40, and Bertrand Divet, 34. Gladius will hire about eight additional workers, including former colleagues of Sethi’s from Chicago-based Citadel, said the person, who declined to say how much money Sethi is seeking to raise.

Gladius, named after a type of two-edged sword used by Roman soldiers, will trade volatility on stocks, bonds and currencies using both exchange-traded contracts and private, over-the-counter securities, according to the person.

Betting on Volatility

Volatility is the key variable in determining the prices of options, which are derivatives that give the right to buy or sell a security at a set price and date. Investors increasingly regard volatility as a distinct asset class, such as stocks or commodities, and use volatility strategies to hedge against losses and wager on price swings.

Volatility hedge funds outperformed most strategies last year after the VIX, the benchmark for U.S. options prices, surged to a record and the Standard & Poor’s 500 Index plunged 38 percent, its worst year since 1937.

The eight-member Newedge index gained 0.64 percent through February, when the S&P 500 dropped 19 percent. Hedge funds lost 1.1 percent, according to Hedge Fund Research.

Hedge funds are private, largely unregulated pools of capital whose managers can buy or sell any assets, bet on falling as well as rising asset prices and participate substantially in profits from money invested.

Citadel, JD Capital

Sethi worked for Ken Griffin’s Citadel for four years before leaving in February 2008. He was previously a portfolio manager covering volatility arbitrage at JD Capital Management LP, a Greenwich, Connecticut-based hedge fund, and had worked in Morgan Stanley’s equity-derivatives trading group in London.

He graduated with a master’s degree in mathematics from the University of Chicago and obtained a bachelor’s degree in chemistry from Cornell University in Ithaca, New York.

Kedia worked for three years at Citadel, where he was an executive director in the firm’s volatility arbitrage group. He had previously worked at Morgan Stanley for five years.

Divet was head of credit strategies within Citadel’s volatility trading and arbitrage group and was head of BNP Paribas SA’s credit proprietary trading group in New York.

To contact the reporters on this story: Jeff Kearns in New York at jkearns3@bloomberg.net; Saijel Kishan in New York at skishan@bloomberg.net

Last Updated: March 24, 2009 10:37 EDT