From the investors' perspective, redemption fees create a Hotel California for money. But for alternative investment funds, they are becoming increasingly prevalent as a tool to retain capital.
Mt. Kisco, NY (PRWEB) July 18, 2012
In a recent survey of their alternative investment clients, TKS Solutions noticed a trend that more funds are enacting redemption fees as a means to retain capital. Given the struggle that has occurred between the investors’ desire for liquidity and the fund’s desire for a stable capital base, this development is not a complete surprise. However, the complications that are associated with the calculations and accounting implications often catch funds off-guard.
As a result of the recent economic turmoil, formerly dormant investors—who would happily park their money in a fund for years at a time—have become very active, always looking for sources of liquidity. This constant movement causes volatility in the fund’s capital, and firms have looked to various means to counter that movement in order to keep invested capital within their organization.
One approach is for funds to create stringent liquidity gates. While this meets the fund’s goals, investors abhor gates. They complain that managers are creating a “Hotel California for money”, which can never leave—even in times of emergency.
An alternative approach is enacting a redemption fee. This allows investors to withdrawal their money at any time they desire, but for a price. The idea being that most investors will leave their capital within the fund, rather than incur a penalty.
While redemption fees seem like a straightforward solution, they are anything but. There are two all-to-common, but often overlooked, complications in processing redemption fees: the allocation of the fees to the other investors, and the interaction of the fee with the performance fee calculation. Both of these complications combine to break many of the manual tools typically used by fund accountants.
The fees charged on redeeming investors are usually allocated to the remaining investors in the form of revenue. For redemptions which occur at the beginning of the period, capital percentages must be adjusted by the amount of the withdrawal before the “redemption fee revenue” is distributed.
For ending redemptions, a new set of percentages that excludes the withdrawn capital need to be created and used to allocate the redemption fees. Fund accountants must pay particular attention to the allocation percentages used; otherwise a portion of that income could erroneously go to the departing investor.
The other complication relates to the interaction of the incentive fee calculation and the redemption fees. Since the withdrawn amounts are typically determined after incentive fees are charged, an additional step needs to be taken for “end of period” redemptions in funds with incentive fees. For those redemptions, after the incentive fee is calculated, and after the withdrawal amounts are determined, and after the redemption fee income is allocated to the remaining investors, then the incentive fee needs to be re-calculated. That additional step is necessary since the income used to determine the incentive fee did not include the allocated redemption fee “income”. If that step is not done, then the general partner will forever lose out on charging a performance fee on the “income” that was distributed as a result of the redemption.
Funds need to maintain a stable base of capital in order to effectively invest. Investors are always looking for sources of liquidity. Redemption fees are becoming a common device for balancing these opposing desires. Funds can avail themselves to this tool, so long as their back office has the sophisticated systems/processes to handle the complications that arise from processing redemption fees.
About TKS Solutions
TKS Solutions offers unified partnership and shareholder accounting solutions for the financial industry. Its flagship software Penny® - It Works is used to manage over 640 funds, providing automated and instant access to detailed investor data. Penny's open architecture and proven features easily integrate with portfolio accounting and customer relationship management systems, data warehouses and in-house proprietary solutions. Penny is used by leading hedge funds, fund of funds, private equity firms, fund administrators and management companies with assets under management ranging from $50 million to $60 billion. For more information, please visit http://www.PennyItWorks.com.