Protect Me From What I Want

Hedge Funds are infamous for how hard they are to sell.

Most fund products have very specific redemption timelines. Check your 401(k) funds - you can probably liquidate them fairly regularly, with settlement X days after your trading instruction is received. Hedge Funds will tell you nope! You can't! That's fairly standard industry practice, and it's there for a reason. That reason, surprisingly enough, is not just because Hedge Funds are run by cavalier swashbuckling assholes.

Imagine someone lent you 20 bucks and you go out and spend it. The imagine this person calls you a few months later, and says they really need it back today. You have to go dig for the cash unless you can pull it out of your wallet, right? That's what it's like when you're running a fund. The fund pays out your sell order with working capital or sells some investments to raise working capital.

In bad markets, investors are stupid. They sell bottoms regularly - I'm losing money! I have to get out now! That panic impulse has, over time, created enormous wealth loss for individual investors. Individuals suck at timing.

Hedge Funds - along with every other equity-based investment structure or portfolio - are creating a lot of downward pricing pressure because they're being slammed with redemptions after doing poorly over the past quarter and since Jan '08 generally. This forces them to sell assets into weakness. Many are beating the S&P, but in some cases that means you've only lost 18% in the past few months. Guess what! Panicked investors aren't exactly thrilled about this. And they want cash now.

So they call up these funds and try to redeem. But here's the thing - Hedge Funds prevent you from taking your money out! They do this a few ways:

1.) Lockups - when you buy, you agree to stay invested for x period of time
2.) Fees - when you sell too fast, you're forced to pay prohibitive fees
3.) Holdbacks - I'll give you 90% of what you sold now, 10% later
4.) Gates - X amount of money is coming out. We're only paying out Y percent of that because it's crazy!
5.) Sidepockets - certain types of crazily illiquid investments etc. will get "side-pocketed," and a portion of a client's capital account balance will be declared unavailable for redemption

This is not because Hedges are evil and want to keep your money forever. It's so they avoid the twin fund-killing spirals of margin calls and redemption requests that can gut all the capital out of a leveraged hedge fund lickety-split in a down market. Redemptions and cash calls from lending banks typically exacerbate broadly down markets, because people are forced to sell assets simply to pay clients out.

Most people sell their assets too quickly when they decrease in value, born out in study after study. Hedge Funds say that when you invest with us, we're going to make you wait it out and protect you from your own irrational impulses. Right now redemptions are really bad, and a lot of investors are finding out about these policies - disclosed in the offering materials! - when they try to sell in a panic. That will lead to negative stories about the evils of Hedge Funds. But this is actually a good thing!