Redemption Period

Redemption Period

Hedge funds typically limit subscription and redemption possibilities by specifying the dates at which investors can enter the fund, by determining a minimum investment period, the so-called lockup, and by specifying the terms of redemption. The redemption period determines the frequency with which investors can withdraw money from the hedge fund.

Currently, the most common redemption periods are at the end of a month or at the end of a quarter, although we occasionally see much longer periods (e.g., 1 year), particularly for funds investing in rather illiquid markets or securities. Redemption periods are often combined with redemption notice periods that specify how many days in advance investors have to notify that they wish to redeem.

Typically, the notice period is between 30 and 90 days. In addition, hedge funds may impose further restrictions upon redemption, for example, by limiting the number of shares that can be redeemed at any given date or by imposing penalty fees for early redemption.


Combined, restrictions on redemption limit the possibilities of investors to quickly respond to poor past performance of a hedge fund by withdrawing their money. Occasionally, it can take up to six quarters before a desired redemption can be effective.

Aragon investigates the relation between hedge fund returns and restrictions that limit the liquidity of fund investors. His results suggest that share restrictions allow funds to efficiently manage illiquid assets, and these benefits are captured by investors as an illiquidity premium.

Registration Statement

Registration Statement

A registration statement is a part of the process of registering securities in the United States. Many other countries follow similar procedures. The registration process is controlled by the Securities Act of 1933, so called because it defines the rules for securities disclosure.

One of the key provisions of the Securities Act is that the sale of securities in a state must comply with the laws and regulations for that state, even if the securities transaction involved interstate commerce.

Note that most of the Securities Act rules do not apply to unregistered securities (including most hedge funds, commodity pools, private equity partnerships, privately placed stock, bonds, and loans, and many real estate investments). Other laws govern commodities, investment management, broker-dealers, and pension plans.


The registration statement is filed with the Securities and Exchange Commission (SEC). This statement contains information about the issue and the issuing company, as a disclosure to potential investors.

The registration is often called a "red herring" because it contains bold sections in red type, reflecting the preliminary nature of the document. This early document is not considered an adequate disclosure to actual investors, so it must contain a disclaimer announcing that it is not a solicitation to sell securities.

Regulation D Fund

Regulation D Fund

Regulation D (Reg D) is a U.S. regulation that organizes the limited offer and sale of securities without registration under the Securities Act of 1933. It provides three exemptions from the Securities and Exchange Commission’s (SEC) registration requirements, which allow smaller companies to offer and sell their securities very quickly, at low cost, and with lower disclosure requirements than standard public offerings. Most domestic U.S. hedge funds rely on Reg D to place their securities directly to a selected group of investors.

Furthermore, Reg D offerings provide investment opportunities for hedge funds and thus build a hedge fund strategy. A Reg D fund invests in companies that are raising money using Reg D. This means that these funds are primarily holding illiquid positions in small-capitalized companies.

Depending on whether equity or convertible bonds are issued, investments take one of two forms. In an equity issue, the hedge fund buys the stocks of the offering company at a discount with respect to the current market price. The stocks are not registered on an exchange and the investor has to observe a holding period before the stocks can be sold on the stock market.


During the holding period, the stocks can only be traded among accredited investors, so that there is hardly any liquidity. In a convertible issue, the investors purchase a convertible bond that can be converted into a specific number of shares at a predetermined price.

The Reg D companies often need immediate financing and offer very attractive conditions to investors. The profit the hedge fund manager tries to capture is the discount between the purchase price and the market value of the publicly traded stocks at issue.

Regulation D Offering

Regulation D Offering

The regulatory basis for offering and selling securities is the Securities Act of 1933, including rules (§§ 230.501–230.508) that govern the limited of er and sale of securities without registration. The latter is known as Regulation D. Common securities of Regulation D offerings are equity and convertible bonds.

Besides Regulation D, there are other exempts from registration, such as for the issue of insurance policies and short-term commercial papers or securities issued by governments, nonprofit groups, common carriers, and banks.

According to the Securities Exchange Act of 1934, companies with more than 500 shareholders, $10 million assets, or those listed on national stock exchanges are required to register. An investment strategy based on these issues is also known as Regulation D investment or PIPE investments (private investments in public entities).


Despite its complexity, Regulation D is an easy method of financing for small companies. Rule 501 provides several definitions, which are applied in rules 504, 505, and 506.

According to Rule 501,

1. accredited investors are typical institutional investors (such as banks, brokers, insurance companies, pension funds, and trusts), private development companies, members of the (top) management of the issuer, and individuals with a net worth of about $1 million or an income of about $200,000 in the two most recent years. 
2. Companies can be issuers, or in case of reorganization, also the trustee or debtor. 
3. The calculation of the number of nonaccredited investors is also ruled.

Rule 502 determines general conditions for Regulation D offerings.

1. The issuer has to inquire whether the purchaser acquires the securities for his own or a third party’s account and the purchaser should not be an underwriter. 
2. The issuer must notify purchasers that securities are not registered under the Security Act and therefore cannot be resold. 
3. General solicitation and advertisement are not allowed. 
4. Just as in registered offerings, documents for nonaccredited investors have to be disclosed. Any information for accredited investors can be made as long as these meet antifraud provisions. All information for accredited investors must be disclosed to nonaccredited investors as well. 
5. The issuer must be available to answer questions by prospective purchasers. 
6. For non-accredited investors a certified financial statement must be provided by an independent public accountant (in some cases the company’s balance sheet or the audited financial statements prepared under the federal income tax laws are sufficient).

Rule 503 specii es the filing of notice of sale (505/506). Within 15 days at er the first sale of securities, the issuer has to file Form D to the SEC, which includes names and addresses of the company’s owners and stock promoters. Registration of securities and sending of reports to the SEC are not required.

Three exemptions for limited offerings and sales without registration are named in rules 504, 505, and 506.

Rule 504 exempts offers and sales of securities that do not exceed $1 million in any 12 month period. Before the small business initiatives (August 1992), the general rules 501, 502, and 503 have to be met. Thereafter, under certain conditions there can be a public offering of securities up to $1 million to an unlimited number of investors of any kind, without delivery of disclosure documents.

It is required that the issuer is not a blank check company and does not have to file reports accordingly to the Securities Exchange Act of 1934. In some cases, state security laws may be stricter. Antifraud provisions have to be abided. This means no including or excluding of information that would be false or misleading.

Rule 505 provides the exemption for offers and sales of securities not exceeding $5 million in any 12 month period. An unlimited number of accredited investors and 35 nonaccredited investors are able to buy the offered securities. The definitions (rule 501), the general conditions (rule 502), and the filing of notice of sale (rule 503) have to be met.

Rule 506 provides the exemption for unlimited offers and sales of securities. It is considered as a safe harbor for private offering that arises under Section 4(2) of the Security Act (504 and 505 are small offerings).

An unlimited number of accredited investors and 35 nonaccredited investors are able to buy the offered securities while non-accredited investors have to understand the merits and risks of the investment. Again all definitions (rule 501), general conditions (rule 502), and the filing of notice of sale (rule 503) have to be met.

Compared to full SEC registration, a Regulation D offering has the advantage to be easier, faster, and cheaper. Furthermore the issuer is in safe harbor (legal protection) if all requirements are fulfilled. For small companies, which are fast growing, have large expenses (R&D), or run out of liquidity, Regulation D provides fast new capital.

Under unfavorable market conditions or restructuring, (secondary) public offerings are often not possible for small and unknown companies. In the past, high-tech, Internet, and biotechnology companies used Regulation D intensely. The danger of losing control of the company exists when toxic PIPEs occur.

Toxic PIPE refers to a situation when convertible bonds are issued and the conversion ratio depends on the future equity price. Through short selling of the equity, the purchaser of the convertible bond reduces the equity price and receives more (in some cases the majority) shares.

Investors of Regulation D offerings often receive a discount on the security price due to the restriction on reselling them. Moreover it is possible to invest in growing businesses in early stages. The risks of such an investment are illiquidity, uncertain business model of a small company, and the voluntary nature of information received.

Relative Value Arbitrage

Relative Value Arbitrage

Relative value arbitrage not only defines a single strategy but also the combination of all arbitrage strategies such as merger arbitrage, fixed-income arbitrage (credit spread arbitrage, capital structure arbitrage, yield curve arbitrage, mortgage-backed securities arbitrage), volatility arbitrage, index arbitrage, split strike conversions, statistical arbitrage, stub trading, and convertible arbitrage.

Hedge fund managers pertaining to this strategy group execute spread trades to generate positive returns from relative price discrepancies among securities or financial instruments such as equities, fixed income, convertible bonds, options, subscription rights, and futures while simultaneously avoiding market risks.

Here a spread denotes the deviation of a security from its theoretical/fair value and its historical average or from the economic relation of two correlated securities. Once these temporary price anomalies are identified through statistical or fundamental analysis, the over-valued security is sold and simultaneously the undervalued security is purchased, taking into account the respective hedge ratio.


Upon a closer examination, the investments on the relative price relation between two securities independent from the current capital market condition lead to a minimization of directional bias—hence relative value arbitrage hedge funds are also known as "market neutral" hedge funds.

If at er spread trading, beta or market risk still remains, it can be neutralized through options or futures. However, market neutral must not be confused with no risk, as demonstrated in 1998 with the collapse of the widely known relative value hedge fund Long-Term Capital Management (LTCM).

In the current high technology era the spreads based on the violation of one price are very small and only of short-term existence; thus, hedge fund managers try to leverage their returns up to 100 times the company capital. As a result, the credit risk included rises as well. Relative value arbitrage generates profit as soon as the prices of the traded securities revert to their historical average.

Particularly in extreme market situations based on euphoria or panic, it may take a very long time until the prices based on the efficient market hypotheses are reached again. Conversely, it is possible as well for the price anomalies to widen.

Investigations of the performance of relative value arbitrage indices of important database providers show moderate but stable profits with a low correlation toward equity markets. Considering the return distribution, we nevertheless observe fat downside tails, leptokurtosis, and substantial negative skewness.

Reporting Guidelines

Reporting Guidelines

Reporting guidelines give private equity funds detailed recommendations about the disclosure of additional information to investors. They aim to homogenize the information for investors, increase transparency, and thus improve trust and confidence between general partners and investors. Two main reporting guidelines have been developed in the past.

For Europe, the European Venture Capital Association (EVCA) first introduced industry-reporting guidelines in March 2000, which were updated in June 2006. EVCA distinguishes between requirements that fund managers have to report if they claim compliance with the guidelines and recommendations that must not necessarily be followed. Semiannual reports are required; quarterly reports are recommended.

For the United States, the Private Equity Industry Guidelines Group (PEIGG) issued reporting and performance measurement guidelines in March 2005, which were developed under the participation of the British Venture Capital Association (BVCA) and EVCA.


PEIGG guidelines require quarterly reporting. Both EVCA and PEIGG industry-reporting guidelines do not address financial statements of private equity funds but intend to promote additional information on fund level, including capital accounts.

Although on fund level, the information requirements of EVCA and PEIGG are quite similar, EVCA guidelines require much more reporting on portfolio company level, for example, location of head office, business description, co-investors. Interestingly, concerning portfolio companies’ balance sheet items, securities ownership and valuation, and other performance metrics, PEIGG guidelines are more precise than EVCA guidelines.

For reasons of completeness, the private equity provisions of the Global Investment Performance Standards (GIPS) issued by the CFA institute in February 2005 should be mentioned, although they focus primarily on fundraising rather than permanent reporting during the fund’s lifetime.

Reverse Leveraged Buyout

Namibia, Africa

A leveraged buyout transaction of a publicly listed firm that is taken private by a later stage private equity fund (buyout fund) is called going private. The phenomenon of an initial public offering (IPO) of a former public firm after some value enhancing years in the portfolio of a later stage private equity fund is called a reverse leveraged buyout (RLBO).

Owing to comparable good data availability, there are some empirical investigations about the long-run performance of U.S. reverse leveraged buyouts in the 1980s. In contrast to the widely documented poor stock prize performance of IPOs and seasoned equity offerings, all authors find no underperformance subsequent to the IPO for reverse leveraged buy-outs.


The results are robust for both market and accounting performance. The results indicate that private equity funds are concerned about the post-IPO performance of their investments since they are repeated players in the IPO market and hold a significant ownership stake in the public firms subsequent to the IPO.

Right of First Refusal

Right of First Refusal

This is a contractual right to enter a business transaction granted by an owner to a potential buyer or investor. The holder of this right is the first party, before anyone else, to be offered the deal, that is, the option of accepting or rejecting a contract with the owner.

Only when the holder turns down the deal is the owner allowed to make the purchase or offer investment opportunity to other potential buyers or investors. For example, a startup company is obliged to offer its investment opportunities first to the venture capitalist that holds the right of first refusal.


If rejected, the company can then shop around for other potential investors. Thus, the holder of the right of first refusal is always the first party to make an of er or a refusal to invest. In addition to being used in private equity, the right of first refusal also applies to many other types of assets such as real estate.

Note that the right of first refusal is distinct from the right of first offer. The latter only requires the owner to engage in exclusive, good faith negotiations with the right holder before turning to other parties while the former is an of er to enter a contract on exact or approximate terms.

Risk Arbitrage

Risk Arbitrage

Risk arbitrage is a hedge fund investment strategy that attempts to profit from the arbitrage spread in mergers and acquisition. Thus, this strategy is also often called merger arbitrage. After a merger or an acquisition is announced, the target company’s stock mostly trades at a discount to the price offered by the acquirer.

The reason for this is that there is no guarantee that the merger will be completed. The difference between the offer price and the target’s stock price is the arbitrage spread that risk arbitrageurs try to capture. If the merger is successful, the arbitrageur receives the arbitrage spread. If the merger fails, the arbitrageur incurs a loss.

There are two types of mergers: cash and stock. In a cash merger, the acquiring company offers to purchase the shares of the target company for a certain amount of cash. Afterward, the target’s stocks trade at a discount to the offer price.


In this situation, the risk arbitrageur buys stocks of the target. He gains if the merger is successful and the acquirer buys the stocks. In a stock merger, the acquirer announces a plan to exchange stocks of the target company in own stocks in a certain exchange ratio.

In this situation, the risk arbitrageur buys stocks of the target company and might go short in stocks of the acquiring company. If the merger is successfully completed, the target’s stock are converted into the acquirer’s stocks based on the given exchange ratio and the hedge fund manager again captures the arbitrage spread.

As it is necessary to build up a long position in the target company and (in case of a stock merger) maybe also a short position in the acquiring company, the liquidity of the stocks involved in merger and acquisition is of great importance for a successful risk arbitrage.

In addition, analysis of the legal situation is necessary, because the approval of the responsible regulator is one of the main impediments to many merger and acquisition transactions.

Risk arbitrage is a typical example of an event-driven strategy. It contains elements of many other hedge fund investment strategies, such as relative value, convertible arbitrage, volatility arbitrage, and statistical arbitrage.

Some authors also consider other trading opportunities in the company’s life cycle as forms of risk arbitrage. To these situations belong stock index reconstructions or stock repurchases, which might offer interesting arbitrage opportunities.

Roadshow

Roadshow

In the process of an IPO, or seasoned equity or bond issue, the roadshow is the moment when the initiative is presented to an audience of institutional investors; the aim is to draw attention to and excite interest in the security offering that will follow (Benveniste and Spindt, 1989; Schulte and Spencer, 2000).

A roadshow (also known as a "dog and pony show") is made up of a series of meetings in which the intermediary or intermediaries that handle the issue (book-runners) introduce the company’s management team and its development projects and business plan to a more or less limited number of institutional investors, portfolio managers, and financial analysts. The aim is to facilitate placement of the securities and/or increase the liquidity of the shares already traded on the stock market.


Since the roadshow depends on the size of the offering, the type of issuer, the profile of target investors, the pre-chosen market, and last but not the least the actual interest shown in initial meetings, it is not possible to determine either the length of this phase (generally it runs from a few days to a few weeks) or the cost.

The roadshow is important for setting the share price for the IPO, because the intermediaries that follow the company can weigh their opinions against those of the people who will deem the initiative a success or a failure. In other words, intermediaries can come up with an of er price that is more in line with the expectations of the public, as observed during the various meetings.