hedge funds

[ibrahim-1987]

hi david:
1. page 59 " side pocket account " : " when existing investors withdraw funds, they STILL remain part of the side pocket account untill it is sold or become liquid "

you mean that they will have access if they want to put money in the fund again? or they can draw their funds but will not receive any return untill fund is sold or become liquid?

2. page 58 " lock-up period ":
" most favored nations" this provision allows an investor to get the best deal that the manager gives to any other investor.

does this mean that investors who do not modify their agreements in term of withdrawl get superior return?

3. Page 62: long equity tranche!
I thought that equity tranche act as O\C only, and can't be sold!
Since it does, what is the source of the return paid on it?
thank y

 

[David Harper CFA FRM]

Hi ibrahim,

(1) and (2) refer to mere summaries of the assigned Stowell chapter. I assume you realize that?
Apologies but I don't have spare time to source statements with additional non-FRM material, so here is the original text (emphasis mine) upon with the notes summary are based:

"A lock-up provision provides that during an initial investment period of, typically, 1 to 2 years, an investor is not allowed to withdraw any money from the fund. Generally, the lock-up period is a function of the investment strategy that is being pursued. Sometimes, lock-up periods are modified for specific investors through a side letter agreement. However, this can become problematic because of the resulting different effective lock-up periods that apply to different investors who invest at the same time in the same fund. Also, this can trigger "most favored nations" provisions in other investor agreements.

A gate is a restriction that limits the amount of withdrawals during a quarterly or semiannual redemption period after the lock-up period expires. Typically gates are percentages of a fund's capital that can be withdrawn on a scheduled redemption date. A gate of 10% to 20% is common. A gate provision allows the hedge fund to increase exposure to illiquid assets without facing a liquidity crisis. In addition, it offers some protection to investors who do not attempt to withdraw funds, because if withdrawals are too high, assets might have to be sold by the hedge fund at disadvantageous prices, causing a potential reduction in investment returns for remaining investors. During 2008 and 2009, as many hedge fund investors attempted to withdraw money

Hedge funds sometimes use a side pocket account to house comparatively illiquid or hard-to-value assets. Once an asset is designated for inclusion in a side pocket, new investors don't participate in the returns from this asset. When existing investors withdraw money from the hedge fund, they remain as investors in the side pocket asset until it is either sold or becomes liquid through a monetization event such as an IPO. Management fees are typically charged on side pocket assets based on their cost, rather than a mark-to-market value of the asset. Incentive fees are charged based on realized proceeds when the asset is sold. Usually, there is no requirement to force the sale of side pocket investments by a specific date. Sometimes, investors accuse hedge funds of putting distressed assets that were intended to be sold during a 1-year horizon into a side pocket account to avoid dragging down the returns of the overall fund. Investors are concerned about unexpected illiquidity arising from a side pocket and the potential for even greater losses if a distressed asset that has been placed there continues to decline in value." --Stowell

3. Yes, equity tranche can be sold (it may or may not be difficult to sell, but ... ). O/C indirectly creates equity by issuing less debt than assets; but structure/SPE can sell equity tranche directly to a third party investor. Source of return is then similar to common stock: anything residual after paying debt tranches. High upside, but absorbs losses so can be lost too.

Thanks,