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ASTA and MAT "Low Risk" Citigroup Hedge Funds?

Falcon and ASTA/MAT, two hedge funds that Citigroup launched last year and marketed to investors as safe fixed-income funds with losses not to exceed 5%, have been decimated by the credit crunch. Citigroup's Smith Barney brokers had sold Falcon and ASTA/MAT as investment funds ideal for conservative retirees. That pitch attracted hundreds of millions of dollars from clients.

So far, the value of Falcon has plunged 75% and ASTA/MAT's worth has dropped more than 90%. But even as the funds deteriorated, Reaz Islam, the manager of the funds, still assured brokers and clients that the funds were expected to make a rebound.

After weeks of internal debate over whether to help their best customers recover some of their losses or do nothing because the risks were outlined to investors, Citigroup finally decided to cover some of the losses. $250 million will be spent to help investors get out of Falcon without absorbing their full losses, but if investors agree, they forfeit all legal claims to the funds. Some ASTA/MAT investors will get a similar offer. One investor who put $500,000 into one of the hedge funds isn't considering these offers and has already filed a federal lawsuit against Citigroup earlier this month.

A few top brokers have quit Citigroup in frustration and one broker, Paul R. Koch, pointed out at Citigroup's annual shareholder meeting last week that the bank seems to be compensating clients "just enough so they don't sue us."

In defense, Citigroup claims that they offered Falcon and ASTA/MAT only to clients with large, diversified portfolios and they outlined the funds' risks in their disclosure and marketing materials. And the funds are suffering from unprecedented market dislocations.

ASTA/MAT invested mainly in municipal bonds while Falcon invested in municipal bonds, mortgage-backed securities, bank loans and other debt instruments. Each fund was made up of different funds that were launched periodically. Boosted by heavy leverage, returns were strong until the credit crunch began last summer.

Last year, Citigroup encouraged brokers at their private bank and at Smith Barney to push Falcon and ASTA/MAT with their best customers because Citi wanted to stabilize Falcon with a cash infusion after market tremors caused Falcon to decline more than 10%. By September, $71 million was raised for Falcon while ASTA/MAT raised about $800 million. Both funds were heavily comprised of retail investors. In the future, Citigroup will scale back its marketing of hedge funds to retail customers.


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