Recently there have been many discussions about hedge fund structures and terms, including the ability (or inability) of investors to withdraw from hedge funds. Generally the manager will have a number of structures in place to make sure that capital stays in the hedge fund. These provisons include the hedge fund gate, the ability to limit all withdrawals in certain circumstances, and the hedge fund lock-up provision.
The hedge fund lock-up provision is a provision which provides that during a certain initial period, an investor may not make a withdrawal from the fund. The period when the investor cannot withdraw the funds is known as the actual lock-up period. Continue reading →
It was very common a couple of years ago, after the hedge fund registration rule, for funds to institute lock-ups of two years or more. After the hedge fund registration rule was effectively vacated by the courts, the lock-ups came down. Many hedge funds now have shorter lock-ups and many choose to go with a 1 year lock-up.
Whatever the time horizon, the issue often arises as to what to do when an investor needs to get out of the hedge fund because of an extreme personal emergency. Almost all hedge fund documents will give the manager the flexibility to allow a redemption in such an instance. However, by doing so, the manager may be disadvantaging the other investors in the hedge fund (including the manager himself).
To discourage early requests for withdrawal (and to compensate the manager or other investors for the potential disadvantage of having to reposition the fund), the manager can institute an early redemption fee. The early redemption fee is simply a fee which is deducted from the withdrawal proceeds. The early redemption fee can be paid to the hedge fund manager, the hedge fund investors, or a combination of the two. The early redemption fee can range anywhere from 1% to 10% with a majority in the range of 2% to 5% of the withdrawal proceeds. Obviously, the exact amount a manager charges will depend on his investment strategy and the extent to which an early withdrawal would disadvantage the other investors and manager.