As hedge funds increasingly explore investment in less
liquid asset classes such as private credit, private equity and
infrastructure, Daniella Skotnicki of Harneys examines
some of the challenges this presents.
In response to market pressures which range from quant and
index funds to political and economic factors, in order to seek
alpha and deliver returns to investors hedge fund managers
are increasingly looking to less liquid strategies such as private
credit, private equity and infrastructure.
Some 35 percent of hedge funds offer private credit products or plan
to by 2020, and 28 percent aim to invest in private equity, according to
EY’s 2018 Global Alternative Fund Survey.
Managers will often seek to add an illiquid component to an
otherwise liquid strategy to bolster decreasing returns; only 16 hedge
funds were able to deliver positive returns before fees in 2018 from a
universe of 450 monitored by HBSC’s alternative investment group.
The demand to adapt the liquidity provisions and structuring of
Cayman funds to manage the diversity of liquidity across investments
has increased and there is an increase in demand for “hybrid funds”
with liquidity and fee terms which include aspects of both liquid and
illiquid strategies. Mechanisms such as side pockets, which for a
period of time went out of favour, are becoming more common.
Illiquid assets within existing funds
Generally, investors in hedge funds structures have the right to
redeem periodically. The typical hedge fund articles of association will
provide certain mechanisms for the management of liquidity such as:
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• A hard or soft lockup period, being a period of time in which the
investors are unable to redeem from the fund or are subject to an
additional fee for doing so;
• Investor or fund level redemption gates which permit only a
specific percentage of net asset value (NAV) to be redeemed on
any redemption date;
• A redemption notice period which requires a certain notice period
for redemptions; and
• Rights to suspend the calculation of NAV, the redemption of shares
and/or the redemption payments.
If a manager is investing a potentially large proportion of the NAV
in illiquid assets, the redemption notice and lockup period may be
insufficient to manage the illiquidity, and managers often prefer not
to rely on suspension rights, as this may give a negative signal to the
market as to fund performance.
Managers of existing funds are also bound by the investment
strategy and restrictions in the offering documents which may not
allow for investment in less liquid strategies
Establishing a separate vehicle
As a result of such issues, managers will often look to establish a
separate vehicle to hold illiquid investments but this, in itself, may