March 27, 2020
Dorothy Mehta comments on how severe volatility in the markets can change the characteristics or availability of certain assets, which could then lead to a deviation in a fund’s investment strategy.
Excerpts from “Style Drift,” HFM Compliance, March 27, 2020:
Managers are trying to determine how to react to this market and what they can and cannot do in response, observes Dorothy Mehta, a partner at Cadwalader, Wickersham & Taft. “They are questioning what to do if there is a material diversion from their stated strategy, whether they will need to divest certain assets to be in compliance, or can they add an asset class, and how and when they communicate changes to investors to minimize a downturn in their portfolio.”
. . .
Apart from the need to disclose style drifts to investors, at the least, if the drift is significant enough managers may have to give investors a chance to redeem, the offending assets may have to be divested or the manager will have to update the governing documents to reflect the strategy shift.
Even more severe, Mehta says, is the risk of litigation. “There may be private rights of action if a manager violates disclosures to investors, as well as breach of contract claims for relevant provisions built into LPAs or side letters.”
. . .
The materiality of the style drift will determine when and what notifications must be made to investors. A shift is material when the strategy becomes riskier as a result of the new investments and if a significant percentage of the fund will be pursuing the new strategy.
Mehta states: “A lot of managers are reaching out to their clients during this time and letting investors know how things are going, what they are doing and what may have changed. I think this is the right thing to be doing.”