Hedge Funds Can Just Freeze Redemptions… Must Be Nice

Maybe it’s just me, but is anyone else amazed that when hedge funds run into trouble (as many have recently by investing in mortgage-backed securities) and investors ask for their money back, the fund can simply say no? This is astonishing to me.

Now, don’t get me wrong. Managers can run their funds any way they want. Typically, fund rules stipulate that investors can withdraw money only during certain windows (quarterly and annually are most common). That makes sense, as it can be tough to put on positions if people can just come and go as they please. But how about when you ask for your money back during a pre-approved window and the hedge fund comes back and says “Sorry, but we have frozen redemptions.”

Bear Stearns (BSC) did this with their recent funds that ultimately went bust and are being sued right now because of what they allegedly told investors regarding the riskiness of the portfolios when they tried to get their money out.

Why on earth would anyone invest in a hedge fund that gave you no guarantee that you could take your money out if you wanted to? How can hedge funds get away with simply denying one’s request? Do any readers out there invest in hedge funds? Are you worried about wanting to get your money out at some point and being told you can’t? Seems risky to me…

Full Disclosure: No position in BSC at the time of writing

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7 Thoughts on “Hedge Funds Can Just Freeze Redemptions… Must Be Nice

  1. Limited liquidity or relatively illiquid does not do the situation justice. Lockups, specified redemption procedures (biannual, annual, etc.), situations like Bear investors are facing now are all realities that are forgotten during good times. The basic mechanics of getting funds into and out of an investment, especially an LP like a lot of the Hedgies, are too often glossed over. Investor education is the bottom-line here. That’s not to say that an educated investor is not an angry investor, but at least there was some discussion and this isn’t coming completely out of left-field.

    In a crisis maybe you see liquidity in a security dry up and bid/asks widen considerably. While the investor can still choose to sell, such a choice may be more difficult given a situation like that. For hedge fund investors, that choice (more like those choices) in that environment can be taken away by the manager.

  2. TheCapitalGame on August 3, 2007 at 6:53 PM said:

    Hedge funds have every right to prevent investors from taking their money out. If you are investing in special situtations i.e. buying assets for 50 cents on the dollar and suppose during a period of irrational panic, those assets fall to 25 cents on the dollar and investors panic and want out, the hedge fund is going to be liquidating a potentially very profitable situation at a huge loss. If a few investors want out, the liquidation will affect all the investors in the fund. Hedge funds have every right to lock investors up for atleast 2-3 years. My investors are locked up for three years and under no circumstances can they withdraw within those 3 years.

  3. Chad Brand on August 3, 2007 at 7:11 PM said:

    I absolutely have no problem with hedge funds having whatever rules in place they want, but do you think they should be allowed to have a specific redemption window (say, semi-annually or annually) from the outset and then refuse to allow clients to do it if times get rough?

    I just think people should know the rules from the beginning. Changing them in the middle of the game doesn’t seem right to me, but that’s just my opinion. In your case, would you ever not allow redemptions after three years even though that was the policy put in-place when they invested?

  4. TheCapitalGame on August 4, 2007 at 9:06 AM said:


    There is a crisis currently in the mortgage CDO market. This crisis is being made worse by the fact that investors are panicking and demanding their money back. Even if the lock in period is over, hedge funds need to brief there clients on the situation and inform them that they will receive their money once the crisis has passed. Right now, mortgage CDOs are way underpriced due to the absence of buyers. This situation I believe is temporary and will work itself out over the next year. Panic liquidation of CDO funds in the short term will only escalate the crisis. What we are seeing is a case of the liquidation of the Bear Stearn funds causing a crisis in all other mortgage CDO funds as investors panic and withdraw money causing a downward spiral effect.
    During this time of crisis, hedge funds have a right to stop investor redemptions.

  5. Chad Brand on August 4, 2007 at 10:19 AM said:

    Regardless of why the freezing of redemptions is insisted upon (I don’t refute your explanation by any means) I still think it opens up hedge funds to massive legal liability, which could eventually result in more regulation than is needed.

    Let’s use the BSC example. Let’s assume there was a redemption window in the fund’s rules. If the fund was down say, 50%, and investors tried to redeem but were told no, and then the fund ended up being worthless within weeks, I think Bear is in trouble with the current investor lawsuits.

    How could the investors lose in court if they want to get that other 50% back. You can’t just breach a contract due to market conditions because you want to.

    If there was no redemption window, or it wasn’t open yet, then I agree with you, as you can’t simply demand money back whenever you want. But if investors have a contractual right to do so, I think the hedge funds that try this tactic will have issues in court.

    Should be interesting to see what happens with Bear.

  6. I think you are both right. What will happen is that both the investors and BSC will argue about the technicalities of the contract, specifically if the investors had the right to withdraw their money or not, as you stated. I predict that the investors will get a little money back, BSC and others in the industry will have to rewrite the contracts more explicitly, and of course, all the lawyers involved will get rich payouts every step of the way.

  7. Anonymous on August 15, 2007 at 9:25 AM said:

    The answer to legal liability is redemption gates that are clearly illuminated in the Offering Memorandum that every fund must issue to any prospective qualified investor. It must be signed by the investor prior to investment so that acknowledges consent to the OM. As with everything, buyer beware.
    A restriction placed on a hedge fund limiting the amount of withdrawals from the fund during a redemption period. The implementation of a gate on a hedge fund is up to the hedge fund manager. The purpose of the provision is to prevent a run on the fund, which could cripple its operations, as a large number of withdrawals from the fund would force the manager to sell off a large number of positions.

    This is a very common provision on a hedge fund and the exact percent of restriction can be found in the hedge fund prospectus. This is a less severe withdrawal restriction than an all out redemption suspension, which doesn’t allow for withdrawals at all. But a gate provision is still seen generally as a negative event.

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