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FRM Part II · FRM Exam Part II · Performing Due Diligence on Specific Managers and Funds

A fund of funds is reviewing the terms of a hedge fund offering quarterly redemptions with 60 days' notice, a 25% investor-level gate, and a one-year initial lock-up. The fund holds relatively illiquid credit positions. Which concern is most directly addressed by the gate?

A gate limits the amount redeemable in a period so the manager need not dump illiquid assets at distressed prices, protecting remaining investors. The cost is delayed exits for redeemers and an incentive to submit redemption requests early.

  1. AIt prevents the manager from charging performance fees on unrealized gains
  2. BIt limits forced asset sales during heavy redemptions, but delays investors' ability to exit and may encourage early redemption requestsCorrect
  3. CIt guarantees investors equal treatment of side letters
  4. DIt eliminates the manager's key-person risk

Explanation

Gates cap redemptions in a period to avoid fire sales and protect remaining investors, but they also trap investors and can trigger a run-like rush to redeem first. They do not affect fee mechanics, side letters or key-person risk.

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