* To redeem shares periodically if funds meet thresholds * CEO sees "only modest improvement" in markets since year-end * Funds significantly reduced holdings in illiquid assets (Adds details from letter, other background)
NEW YORK, Feb 13 (Reuters) - Citadel Investment Group LLC plans to meet redemption requests for its Wellington and Kensington hedge funds over time, distributing cash quarterly if the funds meet certain thresholds, the firm told investors in a letter distributed on Friday.
The plan would partially lift "gates" imposed in December, blocking clients from cashing out their shares amid some of the most turbulent financial markets in decades. Citadel Chief Executive Kenneth Griffin told investors the environment has improved, but not enough to justify totally lifting the gates.
"Given that the world's financial system has seen only modest improvement since year-end, we believe that it is necessary to continue to suspend redemptions," Griffin wrote in the one-page letter, which was obtained by Reuters.
"As our balance sheet continues to strengthen and the liquidity of our investment portfolio continues to improve, we intend to initiate a 'distribution program' and make periodic distributions to investors who desire liquidity," the self-made billionaire said.
The Chicago-based firm, which manages roughly $16 billion in assets, confirmed the letter but declined further comment. Until last year, Citadel had recorded annual gains every year since Griffin founded the firm in 1990 with $4.2 million.
Under the plan, Citadel will determine at the end of each quarter what distributions can be made based on the funds' aggregate capital levels. The threshold levels will decline over time. The letter did not specify the withdrawal schedules of the thresholds.
Whatever funds are available for distribution each quarter will be allocated on a pro-rata basis among the investors. "We believe that this approach is in the best interests of all our investors as we navigate this extraordinary period," he said.
Hedge fund managers perform a balancing act when it comes to redemptions: clients want access to their funds, especially last fall when almost every market was tumbling, yet managers do not want to be forced to sell good investments or illiquid positions at fire-sale prices.
Exceptional volatility and a worsening credit crunch triggered humbling losses last year at many of the best-known funds. The losses and tumbling markets also sparked a surge of redemption requests from clients: about 40 percent of fund assets industry-wise.
Citadel joined on Dec. 13 a number of hedge fund firms that suspended payments on redemption requests. Citadel's funds fell by half last year, with the biggest losses seen after Lehman Brothers collapsed in September.
Fund managers "raise gates," as the practice is called, seeking flexibility to avoid sales that would be forced to meet withdrawal requests.
Yet many investors scrambling to meet margin calls or offset other portfolio losses decried being cut off from their funds.
Griffin told his investors that Citadel has been active in recent weeks shedding hard-to-sell assets and strengthening its balance sheet.
"We have significantly reduced our holdings of illiquid assets, and will continue to do so from a position of strength, in a manner that protects the interests of our investors and the funds," Griffin wrote.
A person familiar with the firm's performance said Citadel's funds were up 5 percent through January, with positive results across several asset classes. (Reporting by Joseph A. Giannone; editing by Jeffrey Benkoe and Matthew Lewis)
Our Standards: The Thomson Reuters Trust Principles.