Investors in Hedge Fund Strategies Increasingly Demanding Separate Accounts to Avoid Gates and Other Consequences of Commingled Investment Vehicles

Faltering hedge fund performance, high profile frauds and prime broker and counterparty failures have combined to heighten the sensitivity of investors in hedge fund strategies to the type of vehicle in which their assets are invested.  In particular, recent events have highlighted the pitfalls to an investor of commingling its assets with those of other hedge fund investors.  One of the major concerns centers around the timing and quantity of redemptions: in a hedge fund, a substantial, simultaneous volume of redemptions can cause a manager to lower a gate or otherwise restrict withdrawals, or leave remaining investors with less liquid assets – and thus redemptions by one investor can decrease the liquidity of other investors.  Side letters are one way to address the concerns raised by commingled assets.  But regulators and even managers are looking increasingly askance on such arrangements.  Another method used to address these concerns involves investors investing in separate accounts, which often invest alongside or otherwise participate in the investment program of a related hedge fund.  We explain, among other things, the various forms a separate account may take, the potentially adverse Advisers Act consequences allowing investors to participate in a strategy via separate accounts and an alternative to separate accounts being used by managers with increasing frequency.

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