The hedge fund also invested about $1 billion in SLM Corp's student lender Sallie Mae. Citigroup shares rose 1.5 percent after the news while SLM's stock was little changed.
In the letter ValueAct sent to clients, the firm said it built its roughly $1.2 billion Citigroup position over the last four to five months and is adding to it "opportunistically."
ValueAct said that the bank could return about $50 billion in cash to shareholders over the next two years, according to the letter. That would be $10 billion more than the $40 billion management has said it intends to return.
"We have been having constructive conversations with ValueAct and welcome them as investors," Citigroup said.
The San Francisco-based hedge fund said the time is right to invest in the banking system because of effective intervention by regulators after the financial crisis and greater transparency.
"The U.S. banking system now has a structurally lower risk profile than any time in our investing lifetimes," ValueAct said in the letter.
It made its investment in Citigroup at a time the bank's stock price has sharply lagged its rivals, including JPMorgan Chase & Co and Bank of America Corp.
But what appeals to ValueAct is the consistent and reliable nature of the bank's business as it services large multinational companies with day-to-day activities, according to the letter. For example, Citigroup manages their cash and the timing of their payments and receipts, as well as hedging out currency risk.
It is less active in the flashier mergers and acquisitions business than some of its rivals but that may be a plus, according to ValueAct's letter. The bank is now "growing in a sustainable fashion" the hedge fund said, adding, it is "less exposed to both earnings volatility and risk of capital impairment and is better capitalized and more securely funded than at any point in our lifetime."
While ValueAct is known as an activist investor, it prefers to conduct discussions with companies behind closed doors instead of on cable television. The hedge fund is often asked to join the board of its investment targets and it said that its partner Brandon Boze has been named chair at the CBRE Group Inc board, where ValueAct has invested roughly $1 billion.
ValueAct now has roughly 40 percent of its capital committed to the financial sector, including on investments in Morgan Stanley and KKR & Co LP.
Earlier in the year, the firm returned some $1.5 billion in capital to investors and said that it is now fully invested. Some large hedge funds have chosen to give money back at a time they have found it tough to find new opportunities.
Since its launch in 2000, ValueAct's flagship fund has gained an average 14.6 percent a year after fees, making for one of the industry's best long-term records.
(Reporting by Svea Herbst-Bayliss in Boston and David Henry in New York; Editing by Lisa Shumaker)
By Svea Herbst-Bayliss and David Henry
