What is a 'Gate Provision'

A gate provision refers to a statement in a fund's offering documents that establishes the fund manager’s right to limit or halt redemptions. The prospectus or offering documents may provide more detail on a gate provision, such as scenarios where redemptions would be restricted or halted entirely. Gate provisions are intended to stop a run on a fund, particularly when the assets a fund holds are illiquid and difficult to turn to cash for redemption in a timely manner. Even with scenarios and guidelines, the decision to exercise the gate provision is the fund manager's.

BREAKING DOWN 'Gate Provision'

Gate provisions restrict redemptions and help to prevent runs on the fund. When a fund, particularly a hedge fund, is holding complex investment products, unwinding positions can take time. The gate provision is built into the fund offering to prevent a situation where redemption requests cost the fund further by forcing liquidation in an adverse market situation.

The Gate Provision in Practice

Fund managers usually need to inform investors in writing when invoking the gate provision. The notification will usually state the need for the provision and outline how much, if any, investors will be able to receive when they request a redemption. Even though they are part of most fund documents, invoking the gate provision is serious business and usually involves a consultation with an attorney. Because a gate provision is invoked at the discretion of the fund manager, investors who find their money locked in understandably question the fund manager’s judgment.

Interestingly, a gate provision doesn't always affect all investors equally. Institutional investors and preferred clients may have a side letter — a separate agreement with the fund — stating that their money will never be locked in. As a result, some hedge funds have eliminated gate provisions altogether because it doesn't actually cover the majority of the capital in the fund.

A Famous Example of a Gate Provision

When a fund enacts a gate provision, it is generally seen as a negative event. There have been cases, however, where a fund manager has used the gate provision to make certain that his or her capital is intact to carry out a critical phase of the strategy. One such situation was popularized in the film "The Big Short" when Michael Burry invoked a gate provision to halt redemptions so that his bet against the housing market wouldn't be liquidated until the mortgage meltdown occurred. His investors enjoyed massive profits after the gate provision was invoked. However, by all accounts, it was extremely unpleasant for all involved when the gate provision was announced.

RELATED TERMS
  1. Hedge Fund Manager

    A hedge fund manager is an individual who oversees and makes ...
  2. Natural Hedge

    A natural hedge is the reduction in risk that can arise from ...
  3. Fund Manager

    Fund managers oversee portfolio of mutual or hedge funds and ...
  4. Legacy Hedge

    A hedge position that a company holds for an extended period ...
  5. Withdrawal

    A withdrawal is removal of funds from an account, plan, pension ...
  6. Redemption Fee

    A redemption fee is a fee charged to an investor when shares ...
Related Articles
  1. Investing

    What Are Hedge Funds?

    Hedge funds may be similar to mutual funds in some ways, but they differ in many others. Learn their distinctions and characteristics here.
  2. Investing

    Hedge Funds Go Retail

    Find out how average investors are breaking into what was once reserved for the ultra rich.
  3. Investing

    Taking A Look Behind Hedge Funds

    Hedge funds can draw returns well above the market average even in a weak economy. Learn about the risks.
  4. Managing Wealth

    HF Performance Report: Did Hedge Funds Earn Their Fee in 2015?

    Find out whether hedge funds, which have come under tremendous pressure to improve their performance, managed to earn their fee in 2015.
  5. Investing

    Hedge Funds' Higher Returns Come At A Price

    Learn how hedge funds win big gains for investors - and why they sometimes lose.
  6. Investing

    Are Hedge Funds Chasing Performance?

    Learn why hedge funds have performed worse than the S&P 500 Index in 2016, and why they may overweight equities to play catch-up in the second half of 2016.
  7. Investing

    Investors Are Turning to ETFs Over Hedge Funds

    Exchange-traded funds have grown to surpass hedge funds in total assets, signalling a major shift in investor strategy.
  8. Investing

    3 Things Divorcees With Hedge Fund Investments Should Know

    Hedge funds are assets that can be very difficult to divide during a divorce.
RELATED FAQS
  1. Are there publicly traded hedge funds?

    See why a privately arranged hedge fund may decide to take its fund public, and how the investing public at large can gain ... Read Answer >>
  2. Can mutual funds invest in hedge funds?

    Learn about mutual fund portfolio management techniques and mutual funds' ability to invest in hedge funds, as well as new ... Read Answer >>
Hot Definitions
  1. Receivables Turnover Ratio

    Receivables turnover ratio is an accounting measure used to quantify a firm's effectiveness in extending credit and in collecting ...
  2. Treasury Yield

    Treasury yield is the return on investment, expressed as a percentage, on the U.S. government's debt obligations.
  3. Return on Assets - ROA

    Return on assets (ROA) is an indicator of how profitable a company is relative to its total assets.
  4. Fibonacci Retracement

    A term used in technical analysis that refers to areas of support (price stops going lower) or resistance (price stops going ...
  5. Ethereum

    Ethereum is a decentralized software platform that enables SmartContracts and Distributed Applications (ĐApps) to be built ...
  6. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
Trading Center