What Is a Gate Provision?

A gate provision is a crucial component in a fund’s offering documents that grants the fund manager the authority to restrict or suspend redemptions. This provision, outlined in the prospectus or offering documents, contains specifics on when redemptions could be limited or completely halted.

The primary purpose of gate provisions is to prevent a sudden rush of redemption requests, especially when a fund holds assets that are illiquid and not easily converted into cash promptly. While guidelines are in place, the decision to invoke the gate provision ultimately rests with the fund managers.

Understanding Gate Provisions

Gate provisions serve as a mechanism to limit redemptions and safeguard against a potential fund “run.” In cases where a fund, particularly a hedge fund, holds intricate investment products, unwinding these positions can be time-consuming. The inclusion of a gate provision in the fund’s offering is aimed at preventing situations where redemption requests could incur further losses through forced liquidation in adverse market conditions.

The Gate Provision in Practice

When a gate provision is activated, fund managers typically communicate this to investors in writing. This notification usually explains the necessity for invoking the provision and details the extent to which investors can access funds upon redemption requests. Despite being a standard feature in fund documents, invoking a gate provision is a serious step that often involves legal consultation. Given that the decision lies with the fund manager, investors may understandably question this judgment when their funds are affected.

Interestingly, the impact of a gate provision may not be uniform across all investors. Institutional investors and preferred clients, through separate agreements, could be exempt from having their funds locked in. Consequently, some hedge funds have opted to remove gate provisions entirely as they may not pertain to the majority of the fund’s capital.

A Famous Example of a Gate Provision

The implementation of a gate provision is typically viewed as a negative event. However, there are instances where fund managers utilize this provision strategically to ensure capital preservation for critical strategic phases.

An iconic example of this was depicted in the movie “The Big Short,” where Michael Burry invoked a gate provision to pause redemptions, safeguarding his bet against the housing market until the mortgage crisis hit. Subsequently, his investors reaped substantial profits following the gate provision’s activation, although the announcement was undoubtedly a challenging moment for all involved.

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