Can a Capital On Call Funding Structure Fit the Hedge Fund Business Model?

For institutional investors in hedge funds, the most objectionable aspect of the recent crisis – even worse than the poor performance – was the evaporation of liquidity, the inability to get one’s money back upon request.  See, e.g., “How Can Hedge Fund of Funds Managers Manage a ‘Liquidity Mismatch’ Between Their Funds and Underlying Hedge Funds?,” Hedge Fund Law Report, Vol. 2, No. 40 (Oct. 7, 2009); “Investors Demand More Specificity in Hedge Fund Governing Documents Regarding Circumstances in which Liquidity Management Tools may be Used,” Hedge Fund Law Report, Vol. 2, No. 30 (Jul. 29, 2009).  In the still-difficult fundraising environment following the crisis, hedge fund managers have been offering variations on the traditional hedge fund structure, all in the interest of accommodating investors’ liquidity concerns and thereby growing or replenishing assets under management.  See “Structuring Managed Accounts Key Focus of GlobeOp’s ‘Managed Accounts Insights for Investors’ Event,” Hedge Fund Law Report, Vol. 2, No. 39 (Oct. 1, 2009); “Steel Partners’ Restructuring and Redemption Plan: Precedent or Anomaly?,” Hedge Fund Law Report, Vol. 2, No. 34 (Aug. 27, 2009); “How Are Hedge Fund Managers with Funds Under their High Water Marks Renegotiating Performance Fees or Allocations?,” Hedge Fund Law Report, Vol. 2, No. 33 (Aug. 19, 2009); “What Happens to High Water Marks When Managers Restructure Hedge Funds?,” Hedge Fund Law Report, Vol. 2, No. 43 (Oct. 29, 2009).  One provocative alternative being explored by certain managers would involve importing the traditional “capital on call” funding approach of the private equity world into the hedge fund structure.  According to sources polled by Hedge Fund Law Report, this approach remains unprecedented.  Nonetheless, in light of the heightened concern with liquidity on the part of hedge fund investors, any technique to enhance liquidity merits a serious look.  Therefore, this article details the different funding mechanisms historically used by private equity and hedge funds, then explores the benefits and burdens to hedge funds of using a capital on call mechanism.

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