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Hedge Fund Liquidity Management

May 17, 2017

George O. Aragon, Tolga Ergun, Mila Getmansky, and Giulio Girardi

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We find that asset illiquidity in hedge funds is typically lower than combined liabilities and equity illiquidity, i.e., hedge funds tend to exhibit negative liquidity mismatch. Using hedge fund regulatory filings of Form PF over 2013-2015, we find that negative liquidity mismatches are more pronounced among larger funds, funds with lower leverage, funds in which managers have a greater personal stake, and when market volatility is lower. We also find support for existing theories of liquidity management: Funds holding more illiquid assets are associated with longer committed periods of investor financing, and the absence of long-term commitments from investors and lenders predicts greater cash holdings and unused borrowing capacity, respectively. Finally, quarterly changes in cash holdings and unused borrowing are negatively related to current and future investor flows and fund returns, suggesting that managers increase liquidity buffers in response to investor outflows, negative performance and ahead of financial distress. Our findings of a negative relation between cash buffer changes and outflows contrast sharply with recent mutual funds studies. We find that hedge funds’ right to enact so-called “discretionary” liquidity restrictions plays an important role in explaining this difference.