The Fund That Gated Its Investors
An open-end fund holds 30% of its assets in illiquid private loans and 70% in listed bonds. Redemptions have surged: investors representing 25% of units have asked to redeem within one month, and the fund's documents allow redemptions monthly with a 30-day notice. The private loans cannot be sold quickly without a discount estimated at 10–15%. The fund's manager proposes to pay redeeming investors partly in kind - transferring a pro-rata slice of the private loans - rather than selling them at a discount. Some investors object, saying they subscribed for cash redemption. The fund's NAV was last struck two weeks ago.
1. Analyse the liquidity mismatch and the options available to the manager.
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The fund promises monthly cash redemptions while holding 30% in assets that cannot be sold quickly without a 10–15% haircut. A 25% redemption request against 30% illiquid holdings means the manager cannot meet it in cash without either selling illiquid assets at a discount (transferring that cost to remaining investors) or using a liquidity tool. Options include: paying in kind, imposing a gate or suspension within the powers in the documents, applying a redemption fee or anti-dilution levy to protect remaining investors, or borrowing short-term against the listed bond portfolio. Each has trade-offs. Selling the loans at a discount harms those who stay; paying cash in full harms them too by crystallizing the discount. In-kind transfer allocates the illiquid assets to those who leave, which is fairer if valued properly, but some investors may not want or be able to hold them.
The manager must act within the fund's constitutional documents and local rules, and treat investors in the same class equally.
2. Evaluate the in-kind proposal and the objection from investors who expected cash.
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In-kind redemption is a recognised tool for funds holding illiquid assets, but it must be permitted by the fund documents and applied consistently. The objection has force if the offering documents promised cash redemption without mentioning in-kind. The manager should check the prospectus and any side letters, and if in-kind is permitted, apply it pro rata, using an independent valuation of the loans rather than the stale NAV. A two-week-old NAV is a problem: if markets moved, the in-kind slice may be mispriced against the redeeming investors or against those who remain.
A fairer package may be a combination: cash from the listed sleeve for part of the redemption, in-kind for the illiquid portion, and an anti-dilution levy to cover transaction costs. If in-kind is not permitted, the manager may need to gate or suspend within the rules, which requires prompt disclosure and regulatory notification. Either way, the manager should communicate clearly, avoid preferential treatment, and document the valuation basis.
3. What should the manager do about the stale NAV and the fairness between redeeming and remaining investors?
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The NAV should be recalculated before any redemption is processed, using current prices for the listed sleeve and a documented fair-value estimate for the private loans. If the loans are carried at par but the market discount is 10–15%, the NAV overstates value and redeeming investors would be paid too much at the expense of those who stay. The manager should apply a valuation adjustment, or at minimum disclose the uncertainty and the method.
Fairness requires that the cost of liquidity be borne by those who cause it. Tools that achieve this include a redemption fee paid into the fund, a swing price or anti-dilution levy, and in-kind settlement at fair value. The manager should treat all investors in the same class identically, avoid negotiating side deals, and keep a clear record. If the fund cannot value its assets reliably, suspension may be the prudent step, with immediate disclosure to investors and the regulator.