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Mounting restrictions on hedge fund withdrawals can erode investor value by as much as 15 percent

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The fast-growing number of withdrawal restrictions being imposed by hedge funds to curtail capital drain during the financial market crisis comes with a hefty price tag for fund investors, says a new study from the Vanderbilt Owen Graduate School of Management. The research comes as investors seek desperately to exit hedge funds to avoid further declines and the possibility of fund failure, yet face a suspension of redemptions by fund managers.

When hedge funds fail, investors can lose the bulk of their investment, so redemption requests tend to increase when the perceived risk of failure rises. However, redemption restrictions prevent investors from exiting, forcing them to accept subsequent losses. According to the study, implied costs to a hedge fund investor from such redemption restrictions can range from 5 to 15 percent at the time of the original investment, with exact amounts highly dependent on fund-specific attributes such as age, expected return and the loss generated by liquidation of fund assets.

"Given that most hedge funds require significant investment levels to begin with, the resulting costs of liquidity restrictions – whether existing or newly imposed – can potentially be staggering for investors," said Nicolas P.B. Bollen, E. Bronson Ingram Professor in Finance at the Owen School.

For example, an investor who deposits $1 million in hedge funds – a relatively modest allocation for such financial products – is essentially paying a fee of as much as $150,000 if their ability to exit is eliminated through future suspension of redemptions.

Bollen, along with Andrew Ang of Columbia Business School, pinpointed the cost of liquidity restrictions by analyzing financial data for more than 8,500 live and defunct funds from the Center for International Securities and Derivatives Markets. Developing a model that treats the ability of an investor to withdraw capital as a "real option," the researchers were able, for the first time, to quantify the associated costs of redemption restrictions.

Although certain restrictions on the ability of investors to redeem their capital from hedge funds – such as lockups and notice periods – are well defined, the ability of managers to suspend withdrawals is often left quite vague in partnership agreements. In some cases, individual fund managers retain varying degrees of discretion when it comes to redemptions. For instance, they may have the authority to process only a portion of a redemption request, known as a gate, retaining the balance of the investor’s capital, and some even have the right to suspend redemptions altogether. According to Bollen, these types of discretionary restrictions on fund withdrawal have the potential to impose much higher costs on investors than standard restriction requirements such as lockups or notice periods.

Given the study’s findings, Bollen suggests that hedge fund investors carefully scrutinize redemption rules – and fund manager discretion – before investing.

"Hedge funds have historically been attractive because of their potential for high returns. What we are now seeing is that, in a serious downturn, investors can face heavy penalties and even be prevented from retrieving their capital should they seek to liquidate their investments, and the implied cost of these restrictions can significantly reduce the return that should be expected from funds," said Bollen.

A PDF of Bollen’s research is available for download at

Vanderbilt Owen Graduate School of Management is ranked as a top institution by BusinessWeek,The Wall Street Journal, U.S. News & World Report, Financial Times and Forbes. For more information about Owen, visit

Media Contact: Amy Wolf (615) 322-NEWS