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Hedge Fund Lock-Ups in Focus after Cerberus Announcement

There have been many questions about the Hedge Fund Lock-ups which were announced by Cerberus Capital today. Many of the explanations & by the major media outlets have been unclear if not incorrect.

One of the main misconceptions with most of the articles presented in the media is that the Lockups will affect existing hedge fund investors. This is not the case, as the Lock-Up period will only be effecting investors who choose to move their investments to the new funds created by Cerberus Capital in the future.

To balance out the 3-year lock-up, the new Cerberus funds will be offering lower management fees. The success of this new structure will no doubt be watched by hedge fund managers around the world.

1. What is a Lock-Up Period?

A lock-up period is the time during which investors are prohibited from redeeming their shares. Hedge funds often have lock-up periods for funds so that the firms are able to take a longer investment horizon. The Lock-Up period is defined in the Fund’s Private Placement Memorandum.

Tradionally a Lock-Up period will be 1 year. With the possibility to redeem every quarter after a 30-60 day notice.

2. Can a hedge fund change a Lock-Up Period?

Yes. A change to the Lock-Up period would require a rewrite of the Hedge Fund’s Private Placement Memorandum (PPM). In most cases this would be considered a Material Change, and would require you to notify your Limited Partners in writing of the update.

Since changing your Lock-Up will have a direct impact on your Limited Partners, many hedge funds choose to give their Limited Partners the option to redeem part or all of their shares before the new Lock-Up period goes into effect.

Instead of changing a lock up period, you could get creative. In the case of Cerberus Partners LP, they chose to halt withdraws from the fund and set up a separate “Special Vehicle” fund which would handle the redemption requests over time.

As you can see there are a lot of legal hurdles to overcome when handling a Hedge Fund meltdown, many of the answers to these questions will be different based on the structure of the fund, or the legal team handling the requests.

3. What Hedge Funds do these lock-up periods apply to?

As announced by Financial times these 3-year lock ups will apply to two new funds, Cerberus Partners II and Cerberus International II. These funds are slated to open in Q4 of 2009.

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About Aaron Wormus

Aaron Wormus works as the Managing Director of Website Creation at HedgeCo Networks and has worked with HedgeCo since the end of 2004. Prior to working with HedgeCo Networks, Aaron managed a private consulting firm based in Frankfurt, Germany. During this time he worked implementing back-end systems for clients ranging from telecommunications companies to mining companies and Silicon Valley software distributors. Aaron Wormus is a published author who has studied Information Technology and Journalism in Finland. His written work has been published in various technology magazines, translated into 5 European languages, as well as published book. Aaron regularly speaks at PHP Programming conferences, and is involved in the organization of his local technology user group.
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2 Responses to Hedge Fund Lock-Ups in Focus after Cerberus Announcement

  1. alexthompson says:

    Do you think lockups will be more or less popular going forward, and are lower management fees really enough incentive for investors to take positions in funds with long lock-up periods?

  2. Aaron Wormus says:

    If your investors trust your investing they will put money in your fund with a three-year lockup. Essentially I see it as a way to weed out the short term investors and investors who are not focused on preservation of capital.

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