Citigroup has shed more than $6 billion in private-equity and hedge-fund assets in the past month in order to comply with new regulations limiting banks’ holdings of “alternative” investments

Updated September 2, 2013, 9:28 p.m. ET

Citigroup Dialing Back Its ‘Alternative’ Holdings

SHAYNDI RAICE

Citigroup Inc. C +2.13% has shed more than $6 billion in private-equity and hedge-fund assets in the past month, according to people familiar with the transactions, in order to comply with new regulations limiting banks’ holdings of “alternative” investments. The nation’s third-largest bank by assets last week sold a $4.3 billion private-equity fund called Citi Venture Capital International for an undisclosed price to Rohatyn Group, a private-equity fund run by Nick Rohatyn, son of financier Felix Rohatyn, said people familiar with the matter. It couldn’t be determined what price the fund fetched. On Aug. 9, Citigroup sold a $1.9 billion emerging-markets hedge fund to the fund’s managers, the people said.Citigroup once was a big player in so-called alternative investments, such as hedge funds and private equity. Its alternative-investments team boasted such high-profile executives as Vikram Pandit, who went on to become chief executive, and Jacob Lew, now U.S. Treasury secretary. As recently as February 2012, the firm managed $18.6 billion in hedge-fund and private-equity assets in its Citi Capital Advisors unit, according to an internal memo reviewed by The Wall Street Journal.

But after the recent deals, Citi Capital Advisors will have only one fund, the $2.5 billion North American private-equity-fund Metalmark Capital. The bank is trying to sell that fund to its management, said people with knowledge of its plans.

The moves reflect a decision by Citigroup to shed its private-equity and hedge funds in the wake of new regulations that restrict banks’ holdings of alternative investments.

The so-called Volcker rule, which is still being finalized but is likely to be implemented within a few years, forbids banks from investing in any funds they don’t manage. It also limits the amount of money banks can invest in private-equity and hedge funds to 3% of their highest grade of capital, known as tier one.

Citigroup isn’t the only firm to rid itself of such holdings. In June, J.P. Morgan Chase & Co. sold its $4.5 billion private-equity operation, One Equity Partners, to the fund’s management. Bank of America Corp. sold a $5 billion fund, North Cove Partners, in 2011 and a $1.4 billion fund, Ridgemont Equity Partners, in 2010.

The Volcker rule is also prompting Goldman Sachs Group Inc. to look into shrinking its investments in private-equity funds, as previously reported by The Wall Street Journal.

Investment firms are using their purchases to bulk up in key areas. Citigroup’s private-equity fund, for example, focuses on emerging markets. The acquisition positions Mr. Rohatyn’s firm to become one of the largest emerging-markets-focused private-equity funds in the world, with more than $7 billion in assets under management.

As part of the deal, Mr. Rohatyn is taking on Citi Venture Capital International’s five funds as well as many employees. The firm is calling the merged fund TRG.

For banks, the sales mark the end of a foray into alternative investments that began with legislation enacted in 1999 that permitted consolidation among different types of financial institutions.

Regulators worried after the financial crisis that banks were taking too many risks with their customers’ deposits and so decided to limit the amounts banks could use to make investments.

Ernest Patrikis, a partner with the law firm White & Case LLP, said he doesn’t think alternative investments were part of the reason banks suffered during the financial crisis, but new regulation is seeking to ensure banks don’t get burned by such investments in the future.

“It wasn’t designed to kill a problem,” Mr. Patrikis said of the limits on alternative investments. “It was designed to kill a potential problem.”

Citigroup got into alternative assets in 2001. In 2007, it bought Mr. Pandit’s hedge fund, Old Lane LLC, for $800 million. Mr. Pandit ran the bank’s alternative-investments unit before becoming chief executive later that year. He stepped down in 2012.

Citigroup in 2009 placed a portion of its alternative investments that were marketed to individual investors in a basket of assets to be sold or wound down. It put its institutional assets into the Citi Capital Advisors unit.

In February, Citigroup sold most of its hedge-fund business to a new entity, Napier Park Global Capital, which had about $6.8 billion in assets under management. Citigroup retains a 24.9% stake in the fund. The minority stake allows the bank to maintain some ownership while complying with new regulations.

Citigroup in August sold the remaining portion of its hedge-fund business, EMSO Partners, to the fund’s management. The fund had about $1 billion in assets under management.

The bank also in August decided to stop investing in new infrastructure deals for a $3.4 billion fund. While the bank is continuing to manage the assets in the fund, the former managers have asked investors if they would be interested in having some of those assets sold to the fund’s former managers, according to a memo reviewed by the Journal.

And, while Citi isn’t seeking to sell off all the assets in the fund, it is considering reducing its stake in Kelda, owner of U.K.-based Yorkshire Water, to 20% from 37%, according to a person familiar with the deal.

Infrastructure funds hold long-term investments, and, as such, Citi’s decision to stop investing in new deals reflects the end of the growth of the fund, said a person familiar with the decision.