UPDATE 2-Citadel to meet all 2008 redemptions this year

* Kensington/Wellington funds up 52 pct through Sept. 1

* Citadel to launch mortgage-focused hedge fund this year (Adds details on new funds, changes since last fall)

By Joseph A. Giannone

NEW YORK, Sept 16 (Reuters) - Citadel Investment Group's flagship hedge funds, which suspended client withdrawals last year as markets plunged, expects to meet all $1 billion of 2008 redemption demands this year as markets and fund values rebound, sources familiar with the situation said.

Citadel's Kensington/Wellington funds, down 55 percent last year as investments in convertible bonds plunged in value, were up 52 percent through Sept. 1, the sources told Reuters.

Efforts by hedge fund managers to suspend, or "gate," redemptions remain a hot-button issue for investors. In the depths of the financial crisis last fall, cash-strapped clients flooded hedge funds with withdrawal demands. Many gates are still in place.

Managers like Citadel decided to block cash outflows because, at the time, markets were frozen and many investments could only be shed at firesale prices.

Investors asked to withdraw $1.5 billion in assets from Citadel's flagship funds last year.

Earlier this year Citadel founder Ken Griffin told investors in those funds -- onshore and offshore versions of the same multiple-strategy portfolio -- that the firm would pay out redemptions quarterly, over time, based on the funds' performance and other considerations.

About $250 million is already set to be paid. Roughly $1 billion will be paid by the end of this year, the sources said, reflecting in part the sharp rebound in convertible markets.

Citadel's funds are having their best year, after posting losses last year that were three times the industry's average. Resurgent markets have helped Griffin's Chicago-based firm go back on offense on a number of fronts.

Citadel recently launched three new single-strategy hedge funds -- equities, convertibles and global macro. It expects to soon roll out a fourth fund, focused on distressed mortgage assets. The firm has raised about $500 million for its new funds since the second quarter, the sources said.

Meanwhile, Citadel Securities, which includes the firm's investment banking, institutional trading and market-making business, has hired 70 employees this year from a number of Wall Street banks.

A Citadel spokeswoman confirmed the securities division hires, reported earlier in a Bloomberg News interview, but declined to comment on hedge fund performance or new funds.

The market upheaval following the collapse of Lehman Brothers and the troubles of American International Group Inc (AIG.N) prompted Citadel to make changes. Leverage, the level of debt piled on top of a firm's equity, was reduced from a multiple of about nine to between four and six, the sources said.

Citadel also reconstructed its flagship funds, reducing the proportion of money pursuing convertible arbitrage and other strategies that seek to exploit price differences between related securities. At this point, Citadel will increase its emphasis on fundamental, research-based investments, the sources said.

Griffin, 40, got his start trading convertibles from his dormitory room at Harvard University some 22 years ago. Citadel today manages $13.5 billion in assets, down a third from its 2007 peak of $21 billion. (Reporting by Joseph A. Giannone, editing by Leslie Gevirtz and John Wallace)