Managing Hedge Fund Risk and Financing: Adapting to a New Era

Funding liquidity Risk management Strategies: Managing Investor Redemptions

A fund manager should have a number of alternatives available to him to ensure that sufficient capital stays in the hedge fund and ensure its funding liquidity at critical times. The extent to which a fund manager must be able to control the amounts, rate, and form of redemptions depends on the liquidity and volatility of the fund's investment portfolio, the amount and stability of leverage provided by his prime brokers, and the level of cash maintained by the fund. Options for managing investor redemptions are discussed below in order of increasing effectiveness and potentially negative impact on investors.

Fund's Ability to Enforce Investor Lock-up Period

Investors can request redemption of their shares at any time. The fund manager has the option, but not the obligation, to honor that request immediately if the fund has sufficient liquid assets on hand. The fund manager is not obliged to make immediate payment because lock-up and redemption notice periods are generally in place to help manage the fund's liquidity risk. Investor lock-up terms define the minimum amount of time an investor must be invested in the fund before redeeming his shares and the amount of notice the investor must give before enacting this right. These terms give the fund manager the right to delay payment until he is legally obliged to do so.

The length of the lock-up is really a business and risk decision that the fund manager ...