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

An investor reviews a fund's terms: quarterly redemptions with 90 days' notice, a 25% investor-level gate, a one-year soft lock-up with a 3% redemption fee, and a manager's right to suspend redemptions at its discretion. The fund holds mostly illiquid, hard-to-value credit assets. Which assessment best reflects the key risk to the investor?

Liquidity is effectively controlled by the manager: discretionary suspension rights and gates, paired with illiquid hard-to-value assets, mean redemptions may be restricted exactly in stress when investors want out. The quarterly dealing schedule and soft lock-up fee overstate how accessible capital really is.

  1. AThe soft lock-up fee makes the fund illiquid regardless of other terms
  2. BThe quarterly dealing frequency is adequate, so liquidity risk is low
  3. CThe notice period is the only relevant term because gates only apply in crisis
  4. DThe discretionary suspension right and gate, combined with illiquid assets, mean liquidity is controlled by the manager and may be unavailable when most neededCorrect

Explanation

Stated dealing terms overstate real liquidity when the manager can suspend or gate and the assets are illiquid. In stress, redemptions are likely to be restricted, so investors bear liquidity risk precisely when they want to exit. A modest lock-up fee is only a minor friction by comparison.

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