Fast and furious redemption withdrawals can seriously impair a fund manager's ability to perform according to his planned investment strategy. Worse, hedge funds often invest in financial securities that are not the most liquid, which means that assets cannot easily be sold for cash. Subsequently, hedge fund managers often place redemption restrictions on investors. A restriction could be on the time an investor must remain with the fund before withdrawing assets, the amount of money that can be withdrawn or both.
Hedge funds place gates, or restrictions, on the way that assets can be withdrawn for the protection of the fund and other investors. It can be damaging to the performance of a fund if a portfolio manager is forced to sell assets at fire-sale or depressed prices in order to generate capital to pay investors. Redemption requests can be considerably more threatening if there is some contagion in the markets that prompts investors to panic and make irrational requests.
Even though hedge fund managers might have good reason to impose restrictions on hedge fund redemption withdrawals, investors' best interest may still be compromised. The best interest of investors essentially comes down to fees. Investors pay high fees to hedge fund managers in exchange for the expertise fund managers provide. Those fees continue to apply as long as an investor has exposure to the fund, and gating techniques could ultimately cost investors up to 15 percent of every $1 million allocation, according to a 2009 article in "The New York Times."
When redemption restrictions are too lenient, it could cost a hedge fund more than managers intended to pay. Cowen Group's hedge fund business was forced to shut down two hedge funds amid rampant redemption requests that crippled the ongoing operation of the funds. Not all investors issued withdrawal requests, but one large client sought to redeem hundreds of millions of dollars. Investors were to receive steady reimbursements until the funds were liquidated, according to the HFM Week website.
Not every hedge fund manager believes in redemption restrictions. Many hedge funds began imposing redemption restrictions during the market crisis in 2008 and 2009 when investor withdrawals were crippling asset sizes. Hedge fund manager John Paulson, who runs Paulson & Co., came out strongly against this practice, according to a 2008 article in "The New York Times." Paulson defended investors' rights to redemption requests and blamed hedge fund managers for any lack of liquidity in a fund.
- Jupiterimages/Photos.com/Getty Images