What is a Gate Provision?
A gate provision refers to a clause within a fund’s offering documents that empowers the fund manager to limit or halt redemptions. These offering documents, such as a prospectus, detail the specific scenarios under which redemptions can be restricted or stopped entirely. The purpose of gate provisions is to mitigate the risk of a fund run, especially when the fund holds illiquid assets that cannot easily be converted to cash for redemption.
Understanding Gate Provisions
Gate provisions serve as a safeguard to restrict redemptions and to prevent fund runs. This is particularly crucial for hedge funds managing complex investment products that require time to unwind. By employing a gate provision, the fund managers aim to avoid forced liquidation of assets during adverse market conditions, thereby protecting the fund’s capital and strategy.
The Gate Provision in Practice
When invoking a gate provision, fund managers must usually inform their investors in writing. This notification details the reasons for the invocation and outlines any partial redemption availability. While gate provisions are standard in many fund documents, invoking one is a considerable decision, often involving legal consultation. Triggering a gate provision can lead to investor dissatisfaction, as their funds may become temporarily inaccessible, provoking questions regarding the manager’s judgment.
Interestingly, gate provisions do not always impact all investors equally. Institutional investors and preferred clients might possess side letters—separate agreements ensuring their capital remains accessible. As such, some hedge funds have opted to eliminate gate provisions because they do not cover the majority of the capital.
A Famous Example of a Gate Provision
Invoking a gate provision generally carries a negative connotation. Nonetheless, there are instances where it ensures the execution of critical investment strategies. One notable example popularized by the film The Big Short involves Michael Burry. Burry invoked a gate provision to halt redemptions, thus maintaining his positions against the impending housing market crash. While the decision initially seemed contentious, it ultimately resulted in significant profits for his investors. However, it was a challenging period for those involved when the provision was enforced.
Note: Investing involves risk, including the possible loss of principal. This information is presented without considering the specific investment objectives, risk tolerance, or financial circumstances of any individual investor and might not be suitable for all.
Related Terms: Run on a Fund, Illiquid Assets, Institutional Investors, Redemption, Prospectus.
