Question

It is only relatively recently that liquidity has received the focus that it deserves with regards hedge fund strategies. Briefly explain why liquidity is such an important issue for hedge fund managers.

Answer 1

We need to know types of liquidity before we need to know why it is important for Hedge Fund Mangers

HIGH LIQUIDITY Assets that can be sold in under 3-4 days For instance, shares in large companies traded on the main stock exchanges

MEDIUM LIQUIDITY Assets that can be sold in under a month For instance, investments in other funds or in private companies that trade monthly

LOW LIQUIDITY Assets that may take up to three months to sell For instance, property, infrastructure, and some rarely-traded private companies and bonds

Basically it is important that hedge managers needs high liquid asset to reduce the risk of heavy loss to investors. Investors may or may not sell the NAV at any point of time hence they should not loss any value.

Key Features of Hedge Funds:

· Sixty percent of a typical fund’s net asset value can be liquidated within 30 days without fire-sale discounting, and the average term of portfolio illiquidity is 71.2 days.

· The terms of investor illiquidity are relatively long-term: nearly 80% of investors’ shares in a typical fund cannot be redeemed within 30 days and the average term of investor illiquidity is 172 days.

· The average terms of portfolio, investor, and financing illiquidity are relatively stable across our sample period, but there is substantial variation across funds. Between the bottom and top quartiles, portfolio illiquidity ranges from about 5 to 90 days, while investor and financing illiquidity range from 50 to 300 and 1 to 60 days, respectively.

· Hedge fund liquidity variables vary significantly with, leverage usage, fund size, and adviser size, but not in ways that are indicative of heightened liquidity risk.