Can hedge funds invest in illiquid assets?
Yes, hedge funds are extremely flexible vehicles and are used by investment managers to pursue strategies across many different asset classes, from the highly liquid to the highly illiquid. Hedge funds that trade illiquid assets often utilize “side pockets,” an accounting mechanism that segregates illiquid investments from each other and from the fund’s liquid securities. Side pockets are designed to treat investors equitably, by allocating the side-pocketed investment to investors on a pro rata basis on the day the investment is made. This mechanism prevents later investors from receiving a stake in illiquid investments that are difficult to value. Likewise, because withdrawals from side pockets are restricted, side pockets prevent withdrawing investors from depleting a fund’s liquid assets to the detriment of the remaining investors. It should be noted that although side pockets serve a constructive purpose, side pockets create opportunities for improper use and have received some negative attention for this reason.