UPDATE 2-Thomas H. Lee mulls shrinking 2 funds - WSJ

(Adds details about THL in paragraph 7)

Dec 4 (Reuters) - Private equity investor Thomas H. Lee may shrink or shut down two funds that had $1.5 billion in assets after suffering losses of about 40 percent this year, the Wall Street Journal reported on Thursday, citing people familiar with the situation.

Hard-hit hedge funds run by Lee farmed out investor money to about 110 other funds, including SAC Capital Advisors and D.E. Shaw Group, according to the paper.

While Lee designed the so-called funds-of-funds to have low volatility with steady, consistent returns, he borrowed heavily to multiply the size of his bets, piling up debt of as much as $3.2 billion, the sources told the paper.

The strategy backfired, and the net asset value of the hedge funds tumbled to just below their level when launched in 2005, the newspaper said, citing an investor.

Lee declined to comment.

Lee launched the namesake private-equity firm in 1974. It has since grown to be one of the largest in the United States. Since quitting the firm in 2006, Lee has focused on a new private-equity firm called Lee Equity Partners and his hedge-fund business, Thomas H. Lee Capital Management LLC, the paper said.

The Boston-based buyout firm which bears his name, Thomas H. Lee Partners, is known as THL.

So-called funds of hedge funds that seek to spread the risk of investing by creating a portfolio of many hedge funds have seen a wave of redemption requests from investors that has forced them to ask the underlying funds to return their money.

Lee's fund started redeeming hedge funds early this year, a source familiar with the situation told the paper. It has about $2.7 billion in assets under management.

The fund started in 2000, and took in outside investors in May 2005. (Reporting by Pratish Narayanan in Bangalore, additional reporting by Megan Davies; editing by Kim Coghill, Jeffrey Benkoe, Richard Chang)