Preparing for Contingent Liabilities: How an Alternative to Hedge Fund Contingency Reserves May Offer More Equitable Investor Treatment (Part Two of Two)

The power to establish reserves for contingent liabilities and other potential fund obligations may be deployed whenever a fund manager foresees a possible future event that could adversely affect the fund. Depending on the outcome of that possible future event (as well as fund policies on adjusting net asset value), contributing, redeeming or “status quo” investors may bear a higher proportion of such contingency reserve. In this two-part guest series, S. Brian Farmer and Alina A. Grinblat, partner and associate, respectively, at Hirschler Fleischer, explore the drawbacks of hedge fund contingency reserves and suggest an alternative structure. In the first article, they explained how hedge fund contingency reserves operate in practice, illustrating how reserves can affect fund shareholders and the unequal treatment that can result. This second article analyzes hedge fund manager motivations in establishing reserves and proposes an alternative structure that may avoid consequent investor inequality. For additional insight from Farmer, see our series on “The Use of Benchmarks to Measure Hedge Fund Performance by Pension Funds and Institutional Investors”: Part One (Jul. 30, 2015); and Part Two (Aug. 6, 2015).

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