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

An investor commits to a hedge fund with a 1-year lock-up, quarterly redemptions after the lock-up, 60 days' notice, and a 25% investor-level gate per quarter. The fund also reserves the right to suspend redemptions in extraordinary circumstances. Which statement best describes the main liquidity risk to the investor?

Gate and suspension provisions can delay full redemption well beyond the stated quarterly schedule, particularly in stressed markets when many investors seek to exit. A 25% quarterly gate alone means a full exit takes at least four quarters, so the nominal terms overstate actual liquidity.

  1. AThe investor can always redeem the full position at quarter-end after the lock-up
  2. BThe gate and suspension rights can delay redemption of the full position beyond the stated schedule, especially in stressed marketsCorrect
  3. CThe notice period protects the investor from delays
  4. DThe lock-up only applies to the manager's capital

Explanation

Gates limit how much can be withdrawn each period and suspension rights allow the manager to halt redemptions, so a full exit may take much longer than the nominal quarterly schedule, particularly when many investors redeem together. The notice period works against the investor, and lock-ups apply to investors.

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