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FRM Part II · FRM Exam Part II · Illiquid Assets

A fund-of-funds allocates to a hedge fund with a 12-month lock-up and quarterly redemptions after that, with 90 days' notice. The risk manager is assessing liquidity mismatch with the fund-of-funds' own monthly-redeemable investors. Which feature most directly gives the fund-of-funds a structural liquidity mismatch?

The mismatch comes from the fund-of-funds offering shorter redemption terms to its investors than it receives from the underlying fund. Monthly liabilities backed by assets with lock-ups, notice periods and quarterly dealing can force it to sell other holdings or gate investors under stress.

  1. AThe underlying fund's performance fee is subject to a high-water mark
  2. BThe fund-of-funds offers shorter redemption terms to its investors than it receives from the underlying fundCorrect
  3. CThe underlying fund reports returns net of fees
  4. DThe underlying fund holds positions in several strategies

Explanation

Liquidity mismatch arises when liability liquidity (investor redemption terms) is faster than asset liquidity (lock-up, notice, quarterly dealing). Monthly investor redemptions funded by assets with lock-up and 90-day notice create the gap. The other features relate to fees, reporting or diversification, not timing of cash.

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