UPDATE 1-Citadel says September was its worst month ever

(Adds details on Citadel performance, industry)

By Mark McSherry

NEW YORK Oct 15 (Reuters) - Citadel Investment Group LLC, one of the world's largest hedge funds with about $18 billion of assets, said September was the single worst month in the history of the company.

Amid turmoil in financial markets, investors with Citadel have been told that its main Kensington fund is now down roughly 22 percent for the year -- but that other funds at the firm are up more than 30 percent.

In a letter to investors obtained by Reuters on Wednesday, Citadel chief executive Ken Griffin said: "September was a devastating month for financial institutions and investors around the world -- September was also the single worst month, by far, in the history of Citadel."

Griffin said Citadel's performance reflected extraordinary market conditions he did not fully anticipate, combined with regulatory changes "driven more by populism than policy."

Griffin told investors that in mid-summer, he decided to reduce risk in Citadel's poorly performing strategies while at the same time increase risk allocation to its "core relative value investment strategies" including convertible bond arbitrage.

"Regretfully, I did not foresee the financial disaster that was to unfold in September," wrote Griffin.

"The financial crisis dramatically raised the cost of borrowing and reduced the availability of credit to market participants, materially reducing the value of cash assets as compared to the value of derivative instruments," added Griffin.

The Citadel chief executive said the decision by regulators around the world to ban the short selling of equities "created material dislocations across many of our portfolios and disrupted our ability to assume and manage risk."

Griffin said he expects Citadel, which for years has treated investors to strong returns, will continue to see significant volatility in its earnings in the weeks to some.

FEARFUL

According to data released last week, hedge funds' losses ballooned last month when the average portfolio tumbled 4.68 percent, marking the industry's worst monthly performance.

The average hedge fund has now lost 9.41 percent this year, data released by Chicago-based performance tracking group Hedge Fund Research (HFR) showed.

The biggest losers in September were hedge funds that focused on energy and basic materials. According to HFR they lost 13.21 percent in September, putting them down more than 20 percent for the year.

Some hedge funds have been facing calls to return money to clients.

Ultra-wealthy investors, who fueled a doubling in hedge-fund industry assets to about $1.9 trillion in the last three years, are increasingly fearful about hedge-fund failures and are pulling their money out.

(Reporting by Mark McSherry; Editing by Gary Hill and Sanjeev Miglani)