What Are Hybrid Gates, and Should You Consider Them When Launching Your Next Hedge Fund?
Hedge Fund Law Report
Gates are provisions in hedge fund governing documents that permit the fund manager to limit the volume of assets redeemed on a given redemption date. The general purpose of gates is to slow the pace of redemptions in down markets and to enable managers to avoid selling assets at temporarily depressed prices. The goal of such devices is to protect long-term fund investors who, in the absence of gates, might be left with a less liquid and less valuable portfolio. Historically, for purposes of determining whether a gate was triggered, the volume of assets sought to be redeemed on a given redemption date was measured at the fund level (fund-level gate). More recently, some hedge fund documents have provided for measurement at the capital account level, on an investor-by-investor basis (investor-level gate). Even more recently – and, admittedly, in just a few cases of which we are aware – managers have launched hedge funds with a novel provision that combines elements of fund-level and investor-level gates. The market has taken to calling such provisions “hybrid gates.” This article explains the mechanics and goals of hybrid gates. In particular, this article discusses: how redemptions are reduced above the gate threshold in the context of fund-level gates; how the pro rata reduction amount is calculated; current practice with respect to priority of carried-forward excess redemptions; whether carried-forward excess redemptions remain subject to fund profit and loss; discounts or penalties for redemptions above a gate threshold; operation of investor-level gates; and examples of hedge funds that have implemented investor-level gates. With that background, the article explains (using a numerical example) how hybrid gates work and why managers may consider using them.