Under certain circumstances, a gating clause allows a hedge fund manager to restrict or completely cut off redemptions from the portfolio due to speciﬁc circumstances or market illiquidity.
In Barron’s Finance & Investment Dictionary: A gating clause, is an agreed upon clause many hedge funds have with their investors, which limits the percentage of the fund’s assets that can be redeemed in a given period. The rationale is that if funds had to fear sudden redemptions requiring liquidity, they would be restricted from profitable long-term bets. Some analysts speculate that, in 2008, the reason hedge funds didn’t fail during the period of heavy deleveraging is explained by gating clauses.
According to Perez (2009); an advisor to ultra high net worth individuals, on his contribution to an Opalesque round Table Series, it was said that performance is an issue when we look at recent hedge fund returns. As many people have called him expressing great distress at the negative performance of their hedge funds or funds of funds during 2008.
He always asked them about the reasons they invested in hedge funds and what exposure they reduced in order to fund the hedge fund exposure. If they were seeking a high-quality bond substitute, they have reason to be distraught, whereas if they were seeking a less volatile equity substitute, then hedge funds delivered the result they were seeking.
However, it wasn’t the negative performance that most shocked investors and advisors, actually some very astute managers decided to take on liquidity risk. His assumption is that a lot of advisors and institutional investors articulate in the following mode: “the GPs have a great track-record and they are asking to go from 10% illiquid to 20%, and gosh, we don’t want to be thrown out so we’d better consent….” The author realised that ironically the managers who did not take on illiquid positions received as many or more redemption notices as did those managers who were side pocketing investments and invoking gating clauses; they were seeking liquidity wherever they could find it.
Barron’s Finance & Investment Dictionary (n.d.), viewed in 10 August 2013 at http://www.answers.com/topic/gate-finance-term
Perez, P., 2009, Opalesque round Table Series, West Coast, pdf
Wiley, J., 2010, “The Hedge fund Book – Hedge Fund Fundamentals”, chapter 1 available at http://media.johnwiley.com.au/product_data/excerpt/39/04705206/0470520639.pdf