Fitch Ratings says that it has ramped up its monitoring of liquidity management at fund of hedge fund managers.

The rating agency reports that it is stepping up its surveillance of FoHF managers and the changing liquidity profiles of their funds “in light of increased redemption activity in the fund of hedge fund industry, expectations for continued outflows and the magnified challenge of liquidity management for FoHF managers.”

Fitch explains that FoHF liquidity risk stems from the fact that investors in these products generally benefit from more frequent and flexible subscription/redemption opportunities than those typically offered to the FoHF itself for investment in the underlying hedge funds. If this risk is not closely managed, Fitch warns, it could result in the manager penalizing the interests of remaining investors or even being unable to meet redemption requirements.

Also, under liquidity stress, a FoHF that must sell some of its underlying funds to maintain liquidity may face redemption penalty fees, which could harm the FoHF’s risk profile, strategy allocation, diversification and, performance, Fitch says.