Client Affairs

Are Managers Handling Hedge Fund Redemptions Fairly?

Tom Burroughes Editor London 11 February 2009

Are Managers Handling Hedge Fund Redemptions Fairly?

With so many investors trying to pull out of hedge funds, the managers of these investment pools need to handle redemptions fairly to bolster shattered confidence in the sector.

Hedge funds have suffered a record bad year in performance and in the rush to withdraw, some clients have been able to get out relatively fast while others have discovered that fine print in contract clauses requires an agonising wait for many months before an exit.

In general, however, investment industry figures say most hedge fund businesses have tried to ensure that nervous investors have been able to pull out without the danger of a “first-come, first-served” stampede with people at the back of any queue being saddled with illiquid, hard-to-value assets. But there are some complaints about how redemptions have been handled and suggestions as to how they can be dealt with more smoothly in future.

The ease or difficulty with which investors can quit a fund varies widely. Data from Credit Suisse shows that only 2 per cent of funds allow investors to pull out after giving a day’s advance notice; 2 per cent require a week’s notice, while 10 per cent of them require a full year’s notice. Some 2 per cent of funds demand a six-month notice period, with 47 per cent requiring 90 days, and 37 per cent requiring a month.

At stake is the reputation of a hedge fund industry that has, depending on one’s viewpoint, proved an expensive disappointment for investors or been unfairly blamed for problems far beyond hedge funds’ control. On average, hedge funds lost more than 18 per cent last year.

There is no official regulatory guidance in the UK or US, for example, on what is considered the fairest way to handle redemptions. As hedge funds are typically based offshore in centres such as the Cayman Islands, redemptions fall outside the remit of the UK Financial Services Authority. When contacted about the matter, the Alternative Investment Management Association, the trade group representing many hedge funds, declined to comment.


Hedge fund managers such as Thames River Capital, GAM (part of Julius Baer), UK-listed RAB Capital, US-based Fortress and Tudor Investment have halted redemptions, significantly curtailed pullouts or restructured their portfolios in recent months. According to Credit Suisse/Tremont, about a quarter of the world's hedge funds are ranked as "impaired" - halting or restricting redemptions. About 17 per cent of all hedge funds have ceased operations; there are now about 7,600 funds around the world. Exact data on funds is, however, hard to come by given the relatively light regulatory climate under which these funds operate.

From a redemption point of view, investors in fund of funds have fared relatively better than those putting all their money into a single strategy, as fund of funds spread across a range of strategies of varying liquidity, said Ausaf Abbas, managing director, private wealth management at Morgan Stanley.

“As far as individual or single strategy hedge funds are concerned, redemptions have not been handled very well.  While the exceptional market conditions left certain funds, particularly those focused on credit or convertibles, with no option other than to restrict liquidity, too many single strategy funds invoked gates despite having substantial liquidity,” Mr Abbas recently told WealthBriefing. In referring to gates, he was speaking of the now-familiar practice of funds limiting how much money can be pulled out in a given period of time.

“This obviously has a straight knock-on effect on fund of fund vehicles, which is compounded by substantial fund of fund investor redemptions. FoF managers have on the whole handled redemptions better and probably done the best job they can in the circumstances,” Mr Abbas said.

The statistics on the scale of redemptions and the number of funds now restricting pullouts are striking. In June last year, hedge fund assets peaked just under $2 trillion before sliding down to $1.4 trillion, a level not seen since 2006, according to Credit Suisse. Redemptions and market falls have erased about $500 billion from fund assets. And the pace of redemptions remains high: Credit Suisse/Tremont, which tracks the industry’s returns, reckons that up to 30 per cent of private investments in hedge funds could be redeemed by early 2009.

Different share classes

One solution to any fear of being left at the back of a redemption “queue” is to split illiquid and liquid hedge fund assets into separate share classes so that all clients get an equal chance of pulling out money, industry figures said.

Morgan Stanley’s Mr Abbas says the use of separate share classes is a sensible one for the long term.

“Creating a separate share class works because it deals with the industry’s current issues in a strategic, rather than piecemeal way.  The only other alternative would be to have continuous monthly or quarterly gating, which only serves to prolong the process and potentially leads to further investor redemptions – not an attractive outcome,” he said.

Further ahead, though, Mr Abbas also feels that fees will be affected as firms try to work out how to handle client liquidity: “For example, we can envisage a scenario where those investors who want short term, say monthly, liquidity, will pay a significant price for it, whereas those investors willing to invest in a share class with less favourable liquidity – say six months - will pay lower fees.  This market-led approach will allow fund of funds to have a better balance of liquidity and will force investors to think more deeply about their appetite for risk,” he adds.

Robin Bowie, chairman of Dexion Capital Holdings, a firm operating listed hedge fund vehicles such as the Dexion Absolute product, is also convinced that separate share classes is a fair way to handle redemptions.

“The operational problem with meeting redemptions is how to not prejudice the stayers while giving the leavers liquidity,” he said. “In these cases, the managers themselves will frequently be the stayers,” Mr Bowie said, pointing out that many managers of hedge funds or fund of funds put their own money into these vehicles and had an incentive to manage redemptions wisely.

“It is legitimate to give oneself time to unwind a portfolio following a balanced format. For example, 15 per cent of a portfolio may take 9 months to unwind, 60 per cent will take five days and 25 per cent will take two months,” Mr Bowie said.

“I think the leavers in November and December had paid the price and have got out at extraordinarily bad levels where they wanted liquidity,” he added.

Darren Lauber, senior portfolio manager at Integrated Alternative Investments, said a first-come, first-served redemption policy would not fit with a fair treatment of customers.

"Some investors have been surprised at how illiquid some of their investment portfolios are. There is an example of a significant macro fund that is invested at up to 30 per cent in illiquid private equity investments that they may not know about. The hedge fund investor has suffered in terms of getting their cash back,” Mr Lauber told WealthBriefing.

"The first rule of investment is how do you get your money back when you want it? It transpires that even in normal times, that when there are high redemptions, it is not possible for people to all get their money out in say, 90 days,” he added.

As a further sign of how hedge fund firms are trying to handle redemptions, the fund manager William Ackman is reportedly cutting his fees and allowing investors to take what is left of their money from one of the funds he manages. Mr Ackman, who runs Pershing Square Capital Management, is suffering huge losses on a fund he started nearly two years ago to bet solely on the rise of the stock of the discount retailer Target Corporation.

One issue that has come to prominence is the use by hedge funds of "side pockets", which are mechanisms within a hedge fund permitting liquid or relatively hard-to-value assets to be separated from the rest of a liquid portfolio and put into a special compartment. Any profit or loss affecting a side-pocket investment is shared by any new investor into a hedge fund.

Some regulatory authorities allow creation of side pockets for the illiquid assets of a fund under certain circumstances. In Switzerland, for example, side pockets can be approved for Swiss funds of hedge funds. Their creation requires prior approval of FINMA, the Swiss regulator, and must be demonstrated to be in the interest of all investors. Furthermore, the rights of all investors must not be affected by the creation of these structures.

 Listed vehicles

As Dexion's Mr Bowie pointed out, one benefit of listed hedge fund vehicles - of which there are now dozens - is that investors can withdraw from a fund by simply selling their shares in a matter of minutes, assuming they are willing to accept the price achievable in the market.

One issue of listed hedge fund vehicles is that their shares can trade at a wide discount to the underlying net asset value of a fund. An investor who buys a listed fund when its NAV is identical to the share price would lose a potential slice of any capital gain if he sells shares when a NAV discount arises. The same issue also affects other listed fund vehicles, such as investment trusts and real estate investment trusts.

As wealth managers ponder some of the lessons of the credit crunch, developing the best, or least-bad way of getting money out of a fund must be one of the most important.


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