Hedge Fund Redemption Restrictions, Financial Crisis, and Fund Performance

This paper examines the impact of hedge fund redemption restrictions such as lockup period, notice period, and redemption period on fund flow, risk, and performance. We first examine the effects of redemption restrictions conditional on past poor performance. We then examine the differential impact of redemption restrictions under different market conditions. We find that during normal periods, funds with more redemption restrictions exhibit significantly higher return, lower volatility, and higher Sharpe ratio. Nevertheless, during the crisis, redemption restrictions show the opposite effect of lower return, higher volatility, and lower Sharpe ratio. We argue that this result is possibly due to that fund managers’ ability to hold on to the ultimately profitable opportunities are largely constrained during the market downturns. We also find that redemption restrictions can effectively prevent fund outflows following poor performance and during the crisis.