Examining the incidence, determinants, and consequences of changes to share restrictions for hedge funds, the author finds that approximately 20% of hedge funds changed their share restrictions over the period of study. Funds with high asset liquidity are more likely to decrease share restrictions, whereas those with high family returns and high cash flows are more likely to increase share restrictions. Hedge funds that actively manage liquidity through the adjustment of share restrictions have lower failure rates.
What’s Inside?
Hedge funds often limit investors’ liquidity through share restrictions. These restrictions include minimum investment requirements, lockup periods (minimum period of time before withdrawals are allowed), limits on redemption frequency, and the requirements of redemption notice provisions. Previous researchers have assumed that share restrictions for hedge funds do not change over time. The author finds that nearly 20% of hedge funds did change their share restrictions over the period of 2007–2012. He examines the incidence, determinants, and consequences of changes to share restrictions for hedge funds.
How Is This Research Useful to Practitioners?
The author presents several useful findings. The incidence of changes to share restrictions is statistically significant over the time period studied; 18.4% of hedge funds studied changed their share restrictions over this period.
Next, the author examines why changes to share restrictions are made. Funds with higher asset liquidity and low liquidity risk are more likely to change (decrease) share restrictions. Share restrictions are also found to be correlated with fund performance and cash inflows. Funds with good performance are more likely to increase share restrictions.
Looking at the consequences of changes in share restrictions, the author finds that funds tend to underperform after decreasing share restrictions. But funds that decrease share restrictions have increased investment flows.
One interesting finding is that funds that actively manage share restrictions have lower failure rates than funds that do not adjust their share restrictions. In addition, funds that increase share restrictions are likely to simultaneously raise fees.
Lastly, the author finds some endogeneity bias in the results. Hedge funds that added a lockup provision during the study period had higher subsequent returns than funds with an initial lockup period. He estimates that approximately 18% of the share illiquidity premium is explained by the dynamic nature of share restriction provisions.
How Did the Author Conduct This Research?
Monthly data on hedge fund characteristics are collected from BarclayHedge for the period of January 2007–May 2012. These characteristics include changes to share restrictions and fee structure for each fund over the period of study. The author also uses this dataset to measure style-adjusted fund performance.
Abstractor’s Viewpoint
The findings of this study are not surprising. The interesting element of this research is that actual changes to hedge fund share restrictions are documented and researched. Previous researchers have assumed that share restrictions are fixed. Their results look only at fixed relationships between share restrictions and asset liquidity, liquidity risk, and performance. The author considers the dynamic nature of share restrictions and concludes that hedge funds that actively manage liquidity are more likely to survive.