Nov. 27 (Bloomberg) -- Blue Wave, the hedge fund started by Carlyle Group in March, lost 9.3 percent this year after credit investments backfired.

The fund, overseen by former Deutsche Bank AG executives Rick Goldsmith and Ralph Reynolds, was hurt in October by bets on structured credit, which can include securities backed by repackaged home loans, according to an investor who declined to be named because returns are private. It had $690 million in assets as of Sept. 30, according to a client letter obtained by Bloomberg.

Blue Wave's decline since March compared with the 10 percent average gain by hedge funds globally and the 6.7 percent return by multistrategy funds that bet on price differences between stocks, bonds and other securities, according to Chicago-based Hedge Fund Research Inc. The losses made Washington-based Carlyle, the world's second-largest buyout firm, vulnerable to client redemptions in its first hedge fund.

``Some very talented people are getting beaten up right now, but that's a rough start for such a successful firm,'' said David Nelson, chief executive officer of Greenwich, Connecticut- based hedge-fund manager DC Nelson Asset Management LLC. He's not an investor in the Carlyle fund.

Carlyle started New York-based Blue Wave to expand beyond buyouts. The fund was up 0.2 percent for the year at the end of September before it fell 9.5 percent during October, according to the investor.

Redemption Terms

Blue Wave clients had until Oct. 15 to request redemptions for Jan. 1. They have the option of withdrawing money quarterly with 65 days' notice, according to the terms outlined in an October client letter. The fund has a set limit for withdrawals during any quarter equal to 20 percent of assets under management. That limit hasn't been reached, according to the investor. The next redemption deadline is Jan. 15.

Carlyle spokesman Chris Ullman declined to comment.

Assets managed by Blue Wave were allocated among four strategies at the start of October, according to the client update. About 26 percent was allocated to credit investments, and 54 percent to bets on rising and falling prices of stocks. The remaining 20 percent was split between wagers on relative price fluctuations between securities and on investments in companies going through mergers and other events.

Short of Target

Carlyle recruited Goldsmith, Blue Wave's chief executive officer, and Reynolds, its chief investment officer, to help the firm take advantage of the growth in hedge funds. Hedge funds have more than tripled their assets since 2002 to more than $1.8 trillion, according to Hedge Fund Research.

The pair previously spent eight years with Frankfurt-based Deutsche Bank. Both are former co-heads of global equity derivatives for the bank. Goldsmith most recently oversaw $7.5 billion including hedge-fund assets at Deutsche Bank Asset Management after he moved to the division in 2004.

Carlyle set out to open Blue Wave with more than $1 billion in assets but fell short of the minimum target by more than $300 million, according to an investor. Blue Wave clients pay a management fee of 2 percent of assets invested and incentive fees of 18 percent to 20 percent on any gains, according to fund documents.

Share Classes

Clients holding Class B shares in Blue Wave agreed to keep their investment in the fund for two years, while owners of Class A shares have the option of withdrawing money during the first year subject to a 3 percent fee, according to fund documents. A class breakdown wasn't given.

Carlyle, founded in 1987 by David Rubenstein, William Conway and Daniel D'Aniello, has expanded beyond leveraged- buyout funds into real estate and venture capital, as well as hedge funds. The firm manages more than $76 billion.

Managers focused on credit were hurt in July and August as rising mortgage defaults sent investors fleeing all but the highest-rated fixed-income securities. Blue Wave had four consecutive monthly gains between 1 percent and 2 percent before it lost 3.1 percent in July and 2.7 percent in August, according to the client update. Its October loss compared with the 3 percent average gain of hedge funds globally and the 2.3 percent average return of multistrategy managers tracked by Hedge Fund Research.

Overall, according to the research firm, October was the best month for hedge-fund managers since a 3.5 percent increase in January 2006.

Hedge funds are private, largely unregulated pools of capital whose managers can buy or sell any assets and participate substantially in profits from money invested.

To contact the reporter on this story: Jenny Strasburg in New York at jstrasburg@bloomberg.net

Last Updated: November 27, 2007 16:27 EST