Veritas – How gating funds in the crisis benefited hedge fund allocators
The en masse gating of money in hedge funds during the global financial crisis caused more bad feelings than the asset management industry had seen for years.
It also achieved three main goals.
Only one of them was intended, and depending on your role during that crisis, you will probably agree more with one of them than with the others.
First, it predictably but unintentionally enraged most affected hedge fund allocators, especially those who believed – and often still believe now – the manager had locked their money in, only to save their own business.
Managers who faced business risk if they paid out have not been forgiven by allocators, especially those running liquid equity or options strategies.
The average hedge fund lost 19% in 2008. In some more extreme cases than ‘the average’, there is no question managers were limiting withdrawals in order to save their own skin.
“They cannot keep my money, it is not theirs to keep,” one gated US allocator said at the time, of a London manager who had locked cash in for two years.
The second goal of gating – the intended one, which most managers highlight – was that it allowed managers to treat all their customers equally.
To meet redemptions freely managers would have to sell large, typically liquid portions in their portfolios at very unfavourable prices, and those investors still in the portfolio were left with a radically different investment to the one they had bought.
Managers have a legal duty to treat customers fairly. Though gating funds was a traumatic experience for all involved – one US hedge manager says he “hopes never to have to use a gate or suspend in any way again” – it was the only action that was available at the time to fulfill this manager duty.
The third consequence of gating was, arguably, to protect investors from their animal instincts – back in 2008/2009, fear – and hitting the panic button and redeeming at the worst possibly time.
It was not managers’ aim to protect their clients from harming their own long-term interests – but is it fair to do so?
In one important sense, no it is obviously not. In free markets, investors should be able to come and go at will. If investors miss gains by entering rising markets too late, or lose money leaving them too early, that is their fault.
But no-one argues investors should buy high and sell low – though selling ever lower is exactly what hedge fund allocators who redeemed $258bn between January 2008 and March 2009 did, or forced managers to do to satisfy withdrawals.