Hedge fund managers are being accused of hanging onto excessively severe restrictions which limit investor redemption requests. With limits of once a month or even quarterly, redemptions has begun frustrating investors who are even being subjected to managers’ stalling to meet redemptions. This is interesting considering investors rebelled against these practices after the credit crisis. When markets plunged in 2007 and 2008, hedge fund managers utilized clauses that let them use “gates” that barred redemptions. This meant many investors could not touch their money, even when funds were needed to plug holes in their portfolios.
Nearly 30 percent of hedge funds placed a restriction on investor liquidity before the markets hit bottom. There was a resultant outcry. A number of financial institutions did change the rules, refusing to put money into a fund that had gates. This did give a lot of hedge funds food for thought, putting ones with restrictions in a minority position.
Activists and investors like Trian Partners are tying their investors in ultra-liquid equity markets, looking to pressure companies to change their strategies. They want redemption windows and underlying fund investments to align, but progress in this has stalled.
Liquidity provisions reflect a balance of negotiation between hedge fund managers and institutional investors. The largest hedge funds promise the longest initial lock up periods despite the damage of redemptions. This is a major reason for “liquid alternatives.” These are mutual funds that promote strategies like those used in hedge funds. It’s a platform that’s traditionally been used for bond and equity investment. These instruments can be sold and bought any day of the week.
The growth of liquid alternatives may change the negotiation power in the investor’s favor. Over the past year an aspect of this strategy has been the equity long-short. This strategy puts both positive and negative bets on listed shares. These take around 30 days for a redemption request to be fulfilled. A liquid copycat shows the transaction can be done in 1/30th of the time.
“Funds of hedge fund” is growing in mutual fund form. They provide exposure to core fund managers without the redemption restrictions imposed on direct clients. Now underlying mutual fund managers would attest they offer their investors access to only a limited number of liquid investment ideas but not under the presumed negative circumstances.
With the massive retail investor market opening up, hedge funds are contemplating the launch of their own low cost mutual fund products that would be marketed directly, much like the practice established by Cliff Asness’ AQR. The main categories of liquid alternatives remains small at six but still managed inflows of $4.8 billion in one month alone, a growth of 61 percent over a year earlier.
Many larger hedge funds are hesitant to jump in. They worry that the launch of a mutual fund could eat away at existing business and likely prompt investors to question exorbitant fees. On the other hand, the market’s smaller performers and copycats working with traditional asset management groups are increasingly embracing the concept. It is likely liquid alternatives, or liquid alts, could be in the same category as hedge fund alternatives.
At the end of the day, the race will be determined by relative returns. The good news is once the dust clears there may be winners on both sides of the liquid/illiquid divide. Given a choice, what investor wouldn’t go with the liquid platform? Who would prefer a platform with gates and redemption barriers and lengthy notice periods? These are critical questions, especially if investors are looking for money in the midst of an economic crisis.