While investors in private equity funds are, with limited exceptions, committed to the fund for the relevant term, investors in hedge funds generally are only locked in the fund for an initial period. See “Can a Capital On Call Funding Structure Fit the Hedge Fund Business Model?
,” Hedge Fund Law Report, Vol. 2, No. 44 (Nov. 5, 2009). Following the initial period, hedge funds typically offer quarterly or semiannual liquidity. However, liquidity management – via gates, redemption suspensions, suspensions of the determination of NAV and other measures – remains an imperative among hedge fund managers even as the credit crisis recedes. See “How Can Hedge Fund Managers Prevent or Mitigate Revocations of Redemption Requests?
,” Hedge Fund Law Report, Vol. 2, No. 21 (May 27, 2009). Accordingly, hedge fund managers are implementing a new liquidity management tool known as “rolling lock-up periods.” A fund with a rolling lock-up period requires investors to commit to an initial two- to three-year lock-up, and if the investor does not submit a redemption notice within a set time prior to expiration of the lock-up, the investor is locked-up for another two or three years, and so forth. See “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). Notably, a rolling lock-up may be viewed as an ex ante liquidity management measure, versus tools such as gates and redemption suspensions, which can be viewed as ex post measures. In other words, investors know at the time of investment that they are subject to rolling lock-ups, whereas gates, redemption suspensions and their ilk – regardless of how thoroughly disclosed – invariably remain an unwelcome surprise when imposed. See “Certain Hedge Funds are Using Enhanced Investor Liquidity as a Marketing Tool
,” Hedge Fund Law Report, Vol. 2, No. 22 (Jun. 3, 2009). On the plus side, rolling lock-ups enable managers to invest in less liquid, more unique opportunities – opportunities that may take years to realize, but that are intended to produce appreciable annualized returns. For managers, they are an almost unmitigated good, except they may turn away some liquidity-conscious investors, or require the manager to enter into a side letter with respect to such investors, which most managers would prefer to avoid. On the minus side, investors have to forgo some liquidity. Ideally, they are compensated for that illiquidity with higher returns, but higher returns are not guaranteed, and even in the best case scenario, investors have to wait for such returns. This article examines: what hedge fund lock-ups are generally; the mechanics of rolling lock-ups; the benefits to hedge fund managers of rolling lock-ups; how hedge fund managers can use rolling lock-ups as a negotiating tool in discussions with institutional investors; the benefits to hedge fund investors of rolling lock-ups; the downsides of rolling lock-ups; and the use of rolling lock-ups for hedge funds employing private equity-like strategies.