UPDATE: Sowood Hedge Funds Lose More Than $1 Billion In July

SAN FRANCISCO (Dow Jones) -- Sowood Capital Management LP, a hedge fund firmthat had more than $3 billion in assets, told investors on Monday that its Alphafunds lost more than half their value this month amid turmoil in credit markets.

The Sowood Alpha Fund Ltd. and the Sowood Alpha Fund LP are down roughly 57%and 53% in July, respectively, and about 56% and 51% so far this year, the firmsaid in a letter to clients. MarketWatch obtained a copy of the letter.

Sowood said its net asset value now stands at roughly $1.5 billion, suggestingthe firm lost at least $1 billion in a month.

Sowood was uncertain that it could meet margin calls, so the firm said it soldalmost all of the funds' assets to Citadel Investment Group LLC, a $14 billionhedge fund firm run by Kenneth Griffin.

That deal helped Sowood avoid "forced sales at extreme prices," that wouldhave been made to meet its obligations to counterparties, Sowood explained inthe letter.

Sowood is the latest hedge fund firm to be hit by credit market turmoil. Mostmanagers with such losses have been knocked by trouble in the subprime mortgagemarket. However, Sowood told clients on Monday that a sharp widening of spreadsin the corporate loan market last week triggered its problems.

"We are very sorry this has happened," Sowood Founder Jeff Larson wrote in theletter. "A loss of this magnitude in such a short period is as devastating to usas it is to you."

Harvard University's endowment, which manages roughly $30 billion in assets,has money invested in Sowood. Larson used work at the endowment and left tostart Sowood. The firm is also a favorite among other endowments, hedge fundinvestors said on Monday. Harvard spokesman John Longbrake declined to comment.

'Best option'

In June, Sowood said it lost money as corporate credit spreads widenedsharply, while the equity market didn't move much at all. This was made worse bya decline in liquidity, the firm added.

Corporate credit weakened much more sharply last week, especially in the loanmarket and the market for credit default swaps on loans, Sowood said. (Creditdefault swaps are derivatives that provide the buyer with insurance against adefault).

The losses were manageable until Sowood's counterparties began to "severely"mark down the value of collateral that the firm had posted to back money it hadborrowed. At the same time, Sowood said it became difficult to sell positionsbecause liquidity became very limited for its credit portfolio.

With few buyers, Sowood said it wasn't sure it could meet margin calls fromits lenders, so it decided this weekend to sell almost all of its portfolio toCitadel.

"The arrangement with Citadel provided our best option under thecircumstances," Larson wrote in the letter. "Citadel offered the only immediateand comprehensive solution."

Citadel

Citadel's move shows that despite tightening credit markets in recent weeks,some well-funded investors stand ready to take over distressed players infinancial markets.

"This transaction provides for an orderly transference of risk between theparties," Citadel's Griffin said in a written statement. "We appreciate theprofessional manner in which the Sowood team handled this complex transactionfrom start to finish."

Citadel manages roughly $14 billion in assets and its hedge funds are up morethan 10% so far this year, according to two people familiar with the firm. Thefirm has jumped into several turbulent markets in the past year when otherinvestors were struggling.

When Amaranth Advisors lost $6 billion in September, Citadel moved to pick upthe pieces, buying Amaranth's natural gas, crude oil and power positions withhelp from J.P. Morgan Chase (JPM) .

By the end of September, Citadel's Global Energy portfolios had generatedreturns of 3% in a month, after reorganizing the positions and cutting risk byroughly two thirds. The firm's $10 billion Kensington fund was up almost 25% in2006, through early December. It's generated returns of more than 20% a yearsince the beginning of 1998.

Citadel also stepped into the subprime mortgage market earlier this year,agreeing to buy bankrupt subprime originator ResMAE Mortgage Corp. Citadeloffered to pay $22.4 million, plus a break-up fee of up to $1.5 million to rivalbidder Credit Suisse (CS) .

In a separate transaction, Citadel purchased ResMAE loans for 98.5% of theirface value, or roughly $160 million.

(END) Dow Jones Newswires 07-30-07 2137ET Copyright (c) 2007 Dow Jones & Company, Inc.