Liquidity Issues Receive Mixed Receptions From Hedge Fund Investors
The past two years have brought a great deal of volatility to world markets. Equity markets around the world sharply declined, and in many regions, credit markets collapsed. In addition to dealing with the reality that the world economy was in the midst of a historic recession, many hedge fund investors had to face the fact that they had few options since their capital was not readily available.
BHA analysts have recently heard a number of investors express their desire and need for better liquidity terms from hedge funds. A manager of a fund of hedge funds in England stated that he and many of his colleagues now believe that lock-up periods have given the industry a “black eye”, and that such fund structures that restrict an investor’s ability to access their invested capital is unethical. An investor mentioned an interest in investing in emerging markets, but the firm was hesitant to invest through an emerging markets hedge fund as it had done in the past. The firm preferred to use instruments that provide exponentially better liquidity, while still providing excellent diversified exposure to specific emerging-market nations. The investor believed that an emerging markets exchange-traded fund (ETF) would be the ideal instrument to use rather than an emerging markets-focused hedge fund.
ETFs are relatively new and innovative products that offer investors the diversification of traditional mutual funds or even hedge funds, but with the liquidity of stocks that trade intraday. ETFs enable investors to get excellent diversification, and similar to hedge funds, ETFs allow investors to profit in both up and down markets; investors have the ability to go long or to short certain indexes, regions, and sectors. can also employ leverage that will enhance potential profits and losses, as do many hedge funds. Recently, ETFs have gained a great deal of sophistication through tracking and replicating certain hedge fund strategies. The first such ETF was IQ Hedge Multi-Strategy Tracker (QAI), which was launched in March of this year.
During the past year, BHA analysts have been gauging investor demand for better liquidity terms. One might assume that the effects of this economic recession along with many investors’ inability to gain access to their invested capital, would have led to a strong demand for better redemption terms and a decline in the number of investors that would invest in funds with a lock-up period. However, only part of that assumption is true.
So far in 2009, there has been a strong demand for both monthly and quarterly redemption periods. Of the hedge fund investors interviewed, 585 required monthly liquidity or better, and 815 required quarterly liquidity or better.
Only 32 hedge fund investors stated that they would be comfortable with yearly liquidity, and 307 said they had no preference. Clearly, investors prefer hedge fund managers that can provide defined liquidity terms that are better than semi-annual.
However, it is important to note that lock-up periods have not been neglected by hedge fund investors in their search for a suitable manager. This was articulated by a research analyst at a fund of hedge funds in New York City. She stated that her firm has always and will always be encouraged by funds that have lock-ups as a part of the fund structure. They, like many investors, still see lock-ups as a sign of funds’ stability and operational abilities. Year to date, the ratio of investors that are looking to invest in funds with lock-ups as opposed to those who are not is more than 2 to 1. Of the hedge fund investors profiled by BHA analysts in 2009, 1,151 stated that they would consider a fund that imposes a lock-up, while only 533 stated they would not.
This data clearly shows that investors remain open to lock-up periods. While the majority of investors desire better redemption terms that are more investor friendly, the majority of investors also still see lock-up periods as a sign of stability within a fund. Lock-ups allow managers to avoid redemption outflows that can seriously hamper their operations and even put them out of business.