Tackling Liquidity Problems and Private Funds

Those planning on establishing an open-end fund in Asia or the EU should be mindful of these three important criteria:

• the liquidity of such structures is periodic & depends on liquidity of their assets;
• have a value the general public is well aware of;
• may be promptly sold.

Those wishing to obtain an open-end fund manager license in Europe (or any other jurisdictions) should also keep in mind that they may face issues with illiquidity in a time of crisis. Such problems are exacerbated due to growing requests for buyback from investors seeking to raise cash for managing their assets. Some open-end funds can encounter significant redemption problems; alternatively, they may sustain some serious financial losses related to their portfolios. Because their viability is called into question, eliminating them can be the only way of handling this predicament. Other funds can weather a crisis by utilizing tools included in their statutory documents & designed for tackling liquidity-related problems.

These structures also provide their managing entities with an opportunity to allocate assets by way of repayment. Their investors can distribute their assets directly or by distributing shares via companies created specifically for this purpose. Having this flexibility makes it possible for them to avoid excessive concentration of non-liquid assets in open-ends funds & prevent investors from repurchasing funds.

Individuals interested in setting up a PEF in a foreign jurisdiction should keep in mind that having ‘side pockets’ can be a quite handy management mechanism, allowing managers to separate non-liquid assets from liquid ones. ‘Side pockets’ are accounts used by a hedge fund to differentiate non-liquid assets from liquid investments.

Once investments arrive in ‘side pocket’ accounts, only hedge funds’ members can count on having a share in them. Prospective investors won’t receive a share of proceeds unless profits generated with the help of an asset is realized.

Tools like these may prove to be really helpful for conducting negotiations with potential or exiting investors. Those interested in getting an open-end fund manager license abroad can request that such instruments be included in a contract if they weren’t added to the governing documents of funds before.

 Those managing funds can provide investors with opportunities for co-investment. There are 5 reasons for this:

• opportunities for non-liquid investments in a liquid fund;
• concentration-related problems;
• establishing good relationships with investors & building a reputation for selling non-liquid assets;
• expanding experience;
• ability to differentiate products offered for sale.

Sometimes, capital for co-investment is attracted by creating sub-classes in the already existing subsidiary funds. That way delays & costs that are likely to arise with the creation of an investment fund in the EU can be avoided.

Establishing a PEF Abroad

Unlike an open-end fund, a PEF doesn’t normally provide an investor with a right for a voluntary buyout; hence, a PEF can have a much easier time surviving a liquidity crisis. That said, liquidity-related problems caused by the coronavirus pandemic can affect a portfolio company that such funds invest in.

General partners of PEFs should verify availability of loans & consider providing them whenever it’s necessary, if portfolio companies owned by them face liquidity problems. Another thing they should do is renegotiate agreements on fund management with their investors (co-investors included). That way they’ll demonstrate that they’re fully aware of leverage-related limits & ways of exceeding them. Limited partners can seek liquidity even if they aren’t contractually entitled to it. Appeasing dissatisfied investors may require full partners to provide limited partners with an opportunity of transferring fund shares owned by them to secondary markets.