The Hedge Fund Law Report

The definitive source of actionable intelligence on hedge fund law and regulation

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By Topic: Investment Opt-Out Rights

  • From Vol. 9 No.45 (Nov. 17, 2016)

    How Hedge Fund Managers Can Design an ESG Investing Policy (Part Two of Two)

    There is no one-size-fits-all approach for private fund advisers that incorporate environmental, social and governance (ESG) factors into their investment processes (ESG investing), in part because many early adopters of ESG investing in the hedge fund space have done so at the request of their investors. Consequently, managers have had to develop a variety of approaches to meet the diverse needs of investors without uniform requirements. Some large institutional investors with ESG investing criteria seek to bypass commingled funds and allocate to separately managed accounts, thereby allowing them to dictate the ESG parameters that apply to their accounts. A benefit to an ESG-sensitive investor of investing in a separately managed account is that it provides transparency into the portfolio to (1) ensure the investment manager adheres to the account’s ESG investment parameters; and (2) evaluate the efficacy of the investment from an ESG perspective. Not all investors, however, have sufficient assets to pursue their mandates through managed accounts, forcing them to allocate to managers applying ESG investing policies to commingled funds. This second article in our two-part series discusses various options available to hedge fund managers when adopting an ESG policy and outlines some of the due diligence inquiries managers with an ESG policy should expect to receive from investors. The first article explored the development of ESG investing and its prevalence in the hedge fund space.

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  • From Vol. 6 No.45 (Nov. 21, 2013)

    Investment Opt-Out Rights for Hedge Fund Investors: Regulatory Risks, Operational Challenges and Seven Best Practices (Part Three of Three)

    This is the third and final article in our series on investment opt-out rights in the hedge fund context.  This article continues the discussion of risks associated with opt-out rights, focusing on regulatory and other risks, and concludes with a discussion of seven best practices for minimizing the risks associated with such rights.  The first article in the series explored eight reasons why investors may demand and managers may grant opt-out rights.  See “Investment Opt-Out Rights for Hedge Fund Investors: Rationales, Mechanics, Regulatory Risks and Operational Challenges (Part One of Three),” The Hedge Fund Law Report, Vol. 6, No. 43 (Nov. 8, 2013).  And the second installment addressed the structure and exercise of opt-out rights, as well as regulatory risks associated with offering such rights.  See “Investment Opt-Out Rights for Hedge Fund Investors: Rationales, Mechanics, Regulatory Risks and Operational Challenges (Part Two of Three),” The Hedge Fund Law Report, Vol. 6, No. 44 (Nov. 14, 2013).

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  • From Vol. 6 No.44 (Nov. 14, 2013)

    Investment Opt-Out Rights for Hedge Fund Investors: Rationales, Mechanics, Regulatory Risks and Operational Challenges (Part Two of Three)

    This is the second article in our three-part series on opt-out rights in the hedge fund industry, and legal and operational challenges associated with structuring and implementing such rights.  This article addresses the structure and exercise of opt-out rights, as well as regulatory risks associated with offering such rights.  The first article explored eight reasons why investors may demand and managers may grant opt-out rights.  See “Investment Opt-Out Rights for Hedge Fund Investors: Rationales, Mechanics, Regulatory Risks and Operational Challenges (Part One of Three),” The Hedge Fund Law Report, Vol. 6, No. 43 (Nov. 8, 2013).  And the third article will continue the discussion of risks associated with opt-out rights, focusing on regulatory and other risks, and conclude with a discussion of best practices for implementing such rights.  The intent of this series is to highlight the core tenets of a tool that managers can use to raise capital more effectively.  To offer a simple example: Rather than turning away a pension fund investor with an aversion to tobacco stocks, a manager can grant the pension fund the right to opt out of tobacco-related investments, and accept the investment.  But opt-out rights get significantly more complex, implicating concepts of transparency, liquidity, fiduciary duty and other legal and operational challenges.  This series identifies the headline challenges in this area and offers best practices for addressing them.

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  • From Vol. 6 No.43 (Nov. 8, 2013)

    Investment Opt-Out Rights for Hedge Fund Investors: Rationales, Mechanics, Regulatory Risks and Operational Challenges (Part One of Three)

    Investment products and services exist along a spectrum of customization, and, as a general matter, the bigger the investment ticket, the more customized the investment experience.  At the least customized end of the spectrum are mutual funds, effectively adhesion contracts in which investors typically have discretion over price, quantity and timing, but little else.  See “PLI Panel Addresses Recent Developments with Respect to Prime Brokerage Arrangements, Alternative Registered Funds and Hedge Fund Manager Mergers and Acquisitions,” The Hedge Fund Law Report, Vol. 6, No. 41 (Oct. 25, 2013).  At the most customized end of the spectrum are family offices, and, just short of that, individual hedge fund style investment vehicles such as “funds of one” and managed accounts.  See “RCA Symposium Clarifies Current Market Practice on Side Letters, Conflicts of Interest, Insider Trading Investigations, Whistleblowers, FATCA and Use of Managed Accounts Versus Funds of One (Part One of Two),” The Hedge Fund Law Report, Vol. 6, No. 24 (Jun. 13, 2013).  Even within commingled hedge funds, the rights and obligations of investors are typically not uniform.  Smaller investors generally get the default terms of the PPM, while larger investors sometimes customize their deal by side letter or otherwise.  Side letters often modify default fund terms relating to liquidity and transparency.  Liquidity relates to the right to redeem from a fund, in whole or in part, and transparency relates to the right to know what’s going on in a fund.  But sometimes investors will wish to avoid a specific investment while not redeeming from the fund, in whole or even in part.  That is, investors sometimes want (or need) investment-specific liquidity rather than fund-level liquidity.  In practice, managers can grant investment-specific liquidity by offering investors the right to opt out of designated investments.  The concept of investment opt outs originated (at least within the private fund space) in private equity and still looms larger in private equity funds than hedge funds.  However, as hedge funds pursue an ever-expanding range of investment strategies – some of which resemble classic private equity – more and more managers are being confronted with requests from investors for investment opt-out rights.  Accordingly, The Hedge Fund Law Report is undertaking a three-part series analyzing the rationales for opt-out rights in the hedge fund context, and the legal and operational challenges involved in granting and implementing such rights.  This article, the first in the series, explores eight reasons why investors may demand and managers may grant opt-out rights.  The second installment will address the structure and exercise of opt-out rights, as well as regulatory risks associated with offering such rights.  The third installment will continue the discussion of risks associated with opt-out rights, focusing on regulatory and other risks, and will conclude with a discussion of best practices for implementing such rights.

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