Are the redemption and liquidity requirements demanded by investors affecting hedge fund and fund of hedge fund structures and documentation?

The redemption and liquidity requirements demanded by investors affect the type and liquidity of investments a hedge fund can make, explain Catherine Gardner and Fred Levy at Brown Rudnick in Washington. They say many investors are requiring managers to eliminate or reduce the use of side pockets and want to eliminate the ability of managers to restrict redemptions.

Henry Bregstein at Katten Muchin Rosenman in New York agrees there is increased scrutiny of whether the liquidity of the underlying portfolio matches the redemption terms. “There were any number of instances where underlying hedge fund liquidity for a fund of fund averaged far in excess of fund of fund redemption terms or where illiquid strategies carried quarterly redemption terms,” he notes.

In the Cayman Islands, Jonathan Tonge at Walkers says there “is a tension between funds seeking to have flexible powers to manage the fund in what they determine to be the best interests and investors with bespoke requirements seeking to have these provisions hard-wired into the documents.” He says investors are also “increasingly less willing to rely on side letters. With regard to fund documents, we expect to see greater risk disclosure, including in connection with redemptions in kind.”

These sentiments are echoed by Gray Smith at Appleby in the Cayman Islands. “At the moment new funds are desperate for cash and putting in highly liquid terms, while at the same time maintaining gate and suspension language. However, investors are looking more to protect themselves and side letters, concentrating on liquidity rather than fees, are making a comeback. But that is a risky route for the manager,” cautions Smith.

Simon Firth at Kaye Scholer in London says one consequence of the financial crisis for the fund industry is that the price demanded by investors who agree to be locked in is lower fees, so, for example, a 15% performance fee rather than the standard 20%.

“Others demand more liquidity and enhanced transparency and funds have now been established with daily liquidity and a facility for providing real-time portfolio information,” he points out.

“Investors appear to be demanding greater investor liquidity which is not surprising following recent events in the hedge fund industry,” say Tania Dons and Richard Finlay in the Cayman Islands practice of Conyers Dill & Pearman. This will be reflected in fund documentation. They say they are also aware of an increase in the use of managed accounts and single investor funds for large institutional investors who can dictate terms and not have to compete for liquidity.