Getting Out of a Hedge Fund Investment

A mutual fund investor can sell his shares in a day.  This is because the manager can raise enough capital to redeem the investor by selling stocks or bonds.  They are traded every day at public prices.  Hedge funds may invest in assets that cannot be sold quickly.  To avoid forced selling that would result in a large loss, they add a lockup period to the investment contract.  During this period which may be anywhere from three months to two years, the investor cannot redeem any shares.  The investor can get out of his hedge fund investment by finding a buyer.  Oftentimes, they will turn to a third party, such as a bank or a market provider (such as HedgeBay), to source a transaction allowing the selling investor to retrieve capital and reduce their risk.  The buying investor gets to invest at a low price, a break on manager fees due to "high water marks" (we will explain this later.) and access to a "closed" manager i.e. a manager who is not accepting any more investments.

In May 2009, I attended the 4th Annual Manager Search and Selection Conference at the offices of the New York Society of Security Analysts.  One of the presentations was Growth and Trends for the Secondary Market for Alternative Investments.  Nigel Dawn of UBS and John Roglieri of HedgeBay gave us their views on the Private Equity and Hedge Fund markets.  We will concentrate on what John said and leave Private Equity for another article.  John was the co-head of US secondary market hedge fund transactions.  He worked with investors to find investment opportunities and liquidity for hedge fund positions.  At that time, HedgeBay had completed $1 billion USD in transactions; an estimated 50% market share.  The size of the trades were from $1-100 million USD.  The average discount was 18%.  This means an investment worth $100 could be bought for $82.

Fast forward to December 2010, the discount for October 2010 had finally risen back to 19%; almost par with May 2009.  It retreated in November to 26% due to the ongoing expert network probe by the FBI.  Seeing as no one knows who will be the next fund implicated, some investor are reducing their risk by selling out of any positions and to clean their portfolio of losing investments for 2011.  The links to the articles are Albourne Village and Hedgeco.net.