A friend who works at a single manager fund tells me that they have been one of the lucky few to have attracted substantial investment in the last year or so, but at a cost of much more intrusive due diligence than before. Without complaint, he says that some of it is sensible, but rolls his eyes as he adds that much of it is not. The main problem is that the people coming in “don’t know what the right questions are”.

You could be forgiven for asking why they are there at all if they don’t know what they are there for. Everyone knows that in the wake of the credit crisis, the incessant blow-ups, frauds, suspensions, gates and restructurings have highlighted that due diligence is not optional. We have seen a significant increase in fear, uncertainty and doubt. Most responses to this have been a rush to redeem everything, freeze everything or check everything. A proportionate response, though, means avoiding such knee-jerk reactions.

The rush to redeem everything indiscriminately, as the European retail market did, exacerbated the problem. It is certainly not a crime to want your money back, but the reality is that hedge funds and funds of funds provide, in their way, a specialised liquidity repackaging service. What are the chances that, even in “normal” markets, banks could give all depositors their money back on demand? Already, retail investors judge their managers narrowly on whether or not they gave money back as promised.

We think there are broader issues. For example: are remaining and redeeming investors treated equally? In funds of funds, what are suspended investments actually worth? If redeeming investors get a payout at the stated NAV, are remaining investors getting short-changed if they are left with increasing amounts of unsaleable and overvalued rubbish? The very attribute that is desired by some investors may be a sign of unfair treatment, and the perfect solution – in-specie redemption – is the last thing investors want. It’s quite a paradox.

The freezing option was proposed by some consultants in Q4 of 2008. The general advice against making new allocations, irrespective of strategy or outlook, was quite damaging to the reputation of managers who had no exposure to Lehman, and had neither lost nor stolen their clients’ money. It rather over-shadowed the outperformance of hedge funds against mainstream investments.