• Hedge Funds imposing "gates" to limit redemption
  • Redemption requests now account for 15 to 30% of total hedge fund assets
  • Investors should insist on greater protection in future, says hedge fund consultancy

With the dramatic decline in the value of some hedge funds, increasing numbers of funds are imposing restrictions on investors seeking to exit ("redemptions"). Measures taken to restrict redemptions include "gates," which restrict withdrawals to a certain percentage of the fund; and putting illiquid, hard-to-sell investments outside the main fund using "side pockets." Some funds have suspended redemptions entirely.

According to Castle Hall Alternatives, a hedge fund due diligence consultancy, 75 funds have either gated, suspended or restructured in order to limit redemptions.

Hedge funds can face particular difficulty when meeting redemption requests as illiquid investments may be held for a longer period than the redemption intervals offered - typically from three months to one year.

Funds that have recently imposed redemption restrictions include RAB Capital, Centaurus Capital, GLG partners and Tudor Investment Corp. According to a report by Morgan Stanley, redemption requests are now equivalent to 15% to 30% of total hedge fund assets, specifically 25% to 30% for European and Asian hedge funds, and 15% to 20% in the United States. The report also predicts that the total value of hedge fund assets under management will shrink to $900 billion by the end of the year, down from $1.93 trillion in the first half of 2008.

In a recent paper, Hedge Fund Investing in a New World, Castle Hall argues that the financial crisis will lead to some fundamental changes in the way hedge funds are structured and managed as a result of increasing scrutiny from investors.

For example, it suggests that traditional compensation systems are likely to be challenged and will become more like compensation of private equity firms. Currently, most hedge funds charge a performance fee of 20% of profit each year based on the net asset value (NAV) of the fund. This is contentious as the net asset value includes unrealized appreciation on often difficult to value assets. By contrast, private equity remuneration is based on profit made only on the sale of investments.

Castle Hall also believes corporate governance of hedge funds is likely to be stepped up. It says an immediate priority is having a "board which can provide genuine, active oversight in two key areas: portfolio evaluation and situations in which funds elect to impose gates or suspend redemptions."

Another area where investors should be watchful, it suggests, is in the terms of hedge fund prospectuses. The paper criticises what is calls "prospectus creep," which in recent years it claims has tilted offering documents in favour of hedge fund managers rather than investors. In the future, says Castle Hall, "investors will need greater specificity in fund offering documents."

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