Hedge Fund Terms: Lockup Periods

As it relates to lockup terms, the most important aspect to consider is “what is the liquidity of the underlying securities in which I am investing?” (both from an investor alignment perspective and even more so if a manager is raising money from institutional investors).  First and foremost, an investor will look at the lock-up and redemption terms when evaluating a manager prior to an allocation, and they will compare these terms to the liquidity of the securities the fund is investing in. While a hedge fund does not want to and should not be viewed as a trading vehicle like a mutual fund, it’s important for a  manager to note that while having the capital to work with for an extended period of time is nice, if you’re investing in liquid securities, there is not substantial reasoning for having long-term hard lock-ups like a private equity fund, or a manager investing in hard-to-borrow securities.

With that being said, there are ways to further entice investors to leave their capital in the fund for extended periods of time. Some of the tactics that we have seen managers use include:

• Offering better terms for longer-periods of committed capital: for example, lower incentive and management fees for capital committed for 36 months. 
•  Implementing a ‘soft lock’ policy that provides the investors the ability to redeem their capital but with a small penalty (typically between 2-4%). The justification of this small penalty is to compensate the remaining investors for any negative effects of offsetting the positions earlier than expected in order to meet the redemption