In-Kind Redemptions and In-Specie Transfers: When a Hedge Fund Pays Out in Securities Rather Than Cash

An in-kind redemption is a redemption that a hedge fund settles by transferring assets to the departing investor instead of cash. For a Cayman Islands company the power rests on section 37 of the Companies Act (2025 Revision), which allows shares to be redeemed in such manner and on such terms as the articles of association authorise. It also rests on the offering document that discloses those terms. Whether the fund may use the power, whose choice it is, which assets are handed over and at what value are four separate questions, each tested against the interests of the investors who stay behind. This article covers the authority, the fairness test, the board record, settlement by asset type and the liquidating vehicle alternative.

"In-kind is a legitimate tool and, in a stressed portfolio, often the fairest one. The difficulty is never the power itself; it is the temptation to use it selectively. When we review a proposed transfer we ask three things. Does the document actually permit it? Does the redeeming investor receive a fair slice of the same portfolio, at the same value everyone else is carried at? And would we be comfortable explaining the choice of assets to the investors who remain? If the answer to the third question is uncomfortable, the transfer is usually wrong, however well the paperwork reads." David Lloyd, Chief Executive Officer at CV5 Capital

Executive Summary

Paying a redemption in securities or tokens rather than cash is lawful, common in stressed or concentrated portfolios and frequently misunderstood.

• The authority comes from the articles, partnership agreement or trust deed, read with the offering document; it is not implied.
• Cayman case law treats a "sole discretion" clause as bounded by good faith and rationality, not as an unfettered power.
• The assets transferred should be valued at the redemption NAV and should exist in the portfolio when the redemption falls due.
• A pro rata slice of the portfolio is the default that is easiest to defend; selecting positions needs a documented reason.
• Where assets cannot be transferred, a liquidating vehicle is the alternative, provided it exists and is authorised before the redemption is treated as paid.

What an In-Kind Redemption Is

A redemption in kind, also called an in-specie redemption, discharges a fund's obligation to a redeeming investor by delivering portfolio assets rather than cash. Directive (EU) 2024/927 of 13 March 2024, which amends AIFMD and UCITS, defines it as transferring assets held by the fund, instead of cash, to meet redemption requests. The redemption is struck at NAV in the ordinary way; only the settlement leg changes.

The tool belongs to the same family as gates, suspensions and side pockets, compared in the guide to gates, side pockets and suspensions. Those tools delay, halt or ring-fence for everyone. An in-kind transfer instead moves the liquidation decision to the investor who asked to leave, which is why it is often the least controversial answer in a concentrated book and also the tool most open to selective use.

Constitutional Authority and Whose Election It Is

For a Cayman exempted company the starting point is statutory. Section 37(1) of the Companies Act (2025 Revision) permits a company, if authorised by its articles, to issue redeemable shares. Section 37(3)(c) provides that redemption may be effected in such manner and upon such terms as may be authorised by or pursuant to the articles, and section 37(3)(da) confirms that the articles may authorise the directors to determine those terms. The power to pay in assets rather than cash therefore has to be found in the articles, or in a determination the articles permit; it is not implied by the general power to redeem. A partnership or unit trust reaches the same place through its partnership agreement or trust deed.

The drafting should answer three questions: may the fund settle in assets, is that at the operator's discretion, the investor's election or by agreement, and what valuation, timing and cost rules apply? Most professional-investor hedge fund documents give the operator the discretion; funds with a taxable investor base more often add an investor election.

The offering document and the CIMA Rule

For a mutual fund regulated by the Cayman Islands Monetary Authority, the offering document must do more than mirror the articles. The Mutual Funds Act requires it to describe the equity interests in all material respects. CIMA's Rule on Contents of Offering Documents for Regulated Mutual Funds, issued in May 2020, lists among the required contents the procedures and conditions for the redemption of equity interests. The power to pay in kind is a condition of redemption and belongs there.

Discretion is bounded, whatever the clause says

The Grand Court's decision in Re FIA Leveraged Fund in April 2012, upheld by the Cayman Islands Court of Appeal, is the reference point. The offering memorandum provided that assets paid on a redemption would be valued by the board, in consultation with the investment manager, in its sole discretion. The court declined to read that as an unfettered power, holding that the directors owed a duty to act in good faith which the contractual terms had not impliedly swept aside. On appeal the discretion was described as limited by necessary implication by concepts of honesty, good faith and genuineness. The court also held that a redemption could be satisfied in kind only with assets held in the fund when payment fell due; shares in a special purpose vehicle created months later did not qualify.

The Fairness Test to Remaining Investors

Every in-kind transfer redistributes something between the investor who leaves and the investors who stay. If the departing investor receives the most liquid positions, the remaining investors hold a less liquid book at the same NAV. If it receives illiquid positions at a valuation the market will not bear, the remaining investors have been subsidised. The board's task is to find the point at which neither group can reasonably complain.

Pro rata slice or selected positions

The most defensible default is a vertical slice: the redeeming investor receives its proportionate share of every position, with cash for fractional and non-transferable amounts. Directive (EU) 2024/927 adopts that position for European alternative investment fund managers. It provides that redemption in kind may be activated only for professional investors and only where it corresponds to a pro rata share of the assets held by the fund. A derogation applies to funds marketed solely to professional investors and to exchange-traded index trackers. Member States were required to apply the transposing measures from 16 April 2026. A Cayman fund managed from outside the European Union is not bound by it, but it is a clear statement of what a regulator regards as fair.

Selecting particular positions is not prohibited where the documents allow it, but it requires a reason that can be written down: non-divisible positions, positions the investor is restricted from holding, or the investor's own written request. A wish to shed a position the manager no longer likes, or to preserve liquidity for investors expected to redeem next, does not survive scrutiny.

Valuation at the dealing day NAV

The redemption price is the NAV per share on the dealing day, and the assets transferred should be valued on the same basis at the same point. CIMA's Rule on Calculation of Asset Values for Regulated Mutual Funds, issued in July 2020, requires a regulated mutual fund to maintain a written NAV calculation policy disclosed in the offering document. The policy must give priority to unadjusted market prices, then observable inputs, then unobservable inputs. Rule 5.7 requires that policy to be applied consistently, with deviations affecting the reported NAV disclosed to investors and agreed by the operators in advance. Valuing assets for a transfer at a price other than the one carried in the NAV is precisely such a deviation, so the fund's valuation policy and pricing sources govern the transfer as much as the monthly NAV.

Timing is the second half of the question. Where settlement follows the dealing day, the documents should state whether the entitlement is fixed in units on the dealing day, so the investor bears the movement, or as a cash amount, so the units delivered are adjusted at settlement. Either can be fair; silence is not, because it leaves the board to decide after it knows which way the market went.

Board Approval and the Record

The FIA decision turned in part on evidence. The court found no record that the directors had considered when the assets should be valued, noted that the formal valuation post-dated the distribution by two weeks, and found no engagement with the uncertainty surrounding the asset's value. A discretion that is not visibly exercised is treated as one that was not exercised. The governance discipline CV5 describes for deciding when a hedge fund can suspend redemptions applies here.

Two features deserve emphasis. The valuation should come from the administrator, since Rule 5.8 of the CIMA valuation rule requires the NAV to be calculated by a service provider independent of the manager and the operators. And the minute should be contemporaneous, not a ratification after the assets have moved.

Settlement and Transfer Mechanics by Asset Type

The legal power to pay in kind says nothing about whether a particular asset can be delivered. That depends on the asset, the custody arrangement and, often, a third party's consent. The redemption is settled only when the transfer has completed on the relevant register, ledger or chain and the administrator has reconciled it against the approved schedule.

The digital asset case has become the most common in-kind settlement in newer funds. Investors who subscribed in bitcoin or a stablecoin expect to redeem in the same asset, and an offering document providing for redemption in the reference asset avoids a conversion leg at both ends. Regulated markets are moving the same way: on 29 July 2025 the Securities and Exchange Commission approved orders permitting in-kind creations and redemptions for bitcoin and ether exchange-traded products, previously confined to cash. A private Cayman fund is not subject to that regime, but the mechanism is now accepted institutional practice.

Liquidating Vehicles Where Assets Cannot Be Transferred

Some assets cannot be handed to a redeeming investor at all: a private loan with transfer restrictions, a position in litigation, a token locked in a vesting contract, or a holding too small to divide. The established alternative is to place them in a separate vehicle, issue interests in it to the redeeming investors in proportion to their entitlements, and distribute cash as the assets are realised. In United States practice this is usually a liquidating trust; in a Cayman structure it is more often a special purpose company or a further share class. The redeeming investor's claim is discharged by the issue of the interests.

FIA shows where the structure fails. The court refused to accept shares in a special purpose vehicle that did not exist when payment fell due. A liquidating vehicle therefore has to be established, and authorised by the fund's documents, before the redemption is treated as paid. It also has to be valued on the same basis as the assets it holds, so that no investor is credited with a paper value the vehicle cannot realise.

A liquidating vehicle is distinct from the continuation of an entire fund into a new domicile, which moves every investor and asset together. That route is addressed in CV5's guide to moving a crypto fund to the Cayman Islands by continuation or in-kind transfer. In a liquidating vehicle the investors part ways, so the fairness questions are sharper.

Wind-Downs, Side Pockets and the Redemption Creditor

Wind-downs are where in-kind distribution earns its place. Distributing the remaining positions pro rata, with cash for the fractions, returns value without the market impact of a forced sale. The sequencing, including when the board should stop accepting redemptions and distribute the whole book, is set out in the hedge fund wind-down and closure playbook.

Side pockets interact with in-kind settlement at realisation. Every investor, including one who has already redeemed the liquid portion, holds an interest in the side pocket until then, and an in-kind transfer to the holders is one of the available exits, tested against the same checklist. The design questions are covered in the complete guide to side pockets for investors and managers.

The last structural point is the status of an investor whose redemption has been accepted but not paid. Under section 37(7) of the Companies Act, where shares liable to be redeemed have not been redeemed at the commencement of a winding up, the terms of redemption may be enforced against the company. The amount due ranks behind other creditors but ahead of the remaining members. An in-kind transfer later found ineffective leaves the redemption unpaid and the investor a creditor. That is how the FIA petitioners obtained a winding-up order against a fund that believed it had paid them.

Disclosure, the Auditor and the Tax Touchpoints

The redeeming investor should receive a statement reconciling the redemption proceeds at the dealing day NAV to the assets delivered: each position, the units, the price applied, the costs deducted and any cash balancing amount. Remaining investors are not usually notified of an individual transfer, but one large enough to change the liquidity profile of the book may need to be described in the next investor letter or the audited financial statements. Where investors have an election to redeem in kind, its terms belong alongside the notice periods and gates described in lock-ups, notice periods and redemption terms.

The auditor will test the transfer as a disposal of the assets at the transfer value and a settlement of the redemption liability, and the evidence is the board's own record: authority, valuation, schedule, transfer confirmations and the investor's acknowledgement. Transfers close to or after the year end may be subsequent events. A transfer valued outside the policy, or a liquidating vehicle carried at a value it cannot support, produces a valuation finding and a question from every allocator who reads the financial statements.

Tax is a structural point rather than a drafting one, and depends on the investor's jurisdiction, the vehicle and the asset. Some markets impose a transfer tax or stamp duty on the re-registration of securities, and some exempt in-specie redemptions from collective investment vehicles; the cost allocation should assume the tax applies until confirmed otherwise. For the receiving investor, the transfer usually establishes a new acquisition cost, which is often why a taxable investor asks for in-kind settlement. For the fund, it is a disposal at the transfer value. Each point should be identified before approval, with independent professional advice where uncertain.

Key Takeaways

• Check the articles, partnership agreement or trust deed for an express in-kind power and confirm the offering document discloses it; if either is missing, amend before relying on it.
• Decide at launch whether in-kind settlement is at the operator's discretion, the investor's election or by agreement, and write the timing and cost rules into the same clause.
• Default to a pro rata slice and require a written reason, approved by independent directors, for any departure from it.
• Have the administrator value the assets under the NAV calculation policy at the dealing day, and confirm every asset was held by the fund when the redemption fell due.
• Resolve transferability, wallet verification and third-party consents before the dealing day, and use a liquidating vehicle only where it exists and is authorised in time.
• Minute the decision contemporaneously against a fixed checklist and give the redeeming investor a statement reconciling the NAV proceeds to the assets delivered.

Frequently Asked Questions

Can a hedge fund redeem an investor in securities rather than cash?

Yes, where its constitutional documents allow it. For a Cayman company, section 37 of the Companies Act permits redemption in such manner and on such terms as the articles authorise. The in-kind power therefore has to appear in the articles or in a determination the articles let the directors make. The offering document should disclose the power as a condition of redemption. Without both, the fund should settle in cash.

Is an in-kind redemption the fund's choice or the investor's?

It depends on the drafting. Most professional-investor hedge fund documents give the operator a discretion to pay in kind, some give the investor an election, and some require both to agree. Whichever model is chosen should be stated in the offering document together with the valuation, timing and cost rules, so that neither side is deciding those points after the redemption request has been received.

How are the assets valued in an in specie redemption?

At the same value and the same point as the NAV used to strike the redemption, under the fund's written NAV calculation policy. For a CIMA-regulated mutual fund that policy must give priority to unadjusted market prices and be applied consistently by the independent administrator, with deviations agreed by the operators in advance and disclosed. Cayman case law treats a board's sole discretion over valuation as bounded by good faith and rationality.

Does the fund have to give the redeeming investor a pro rata slice of the portfolio?

Not as a matter of Cayman law, but a pro rata slice is the default that is easiest to defend to remaining investors. The European directive amending AIFMD adopts it as the rule for EU managers unless the fund is marketed solely to professional investors. A fund that selects particular positions should have a documented reason, such as non-divisible or restricted assets or the investor's own written request, and independent directors should approve it.

What is a liquidating trust redemption?

It is the settlement of a redemption by issuing the investor interests in a separate vehicle that holds assets the fund cannot transfer or divide, with cash paid as those assets are realised. The vehicle is commonly a liquidating trust in the United States or a special purpose company in Cayman. The vehicle must exist, be authorised by the fund's documents and be valued on the same basis as the assets it holds before the redemption is treated as paid. Interests in a vehicle created after the redemption fell due did not satisfy the redemption in the FIA case.

Can a crypto fund pay redemptions in tokens?

Yes, and many do, particularly where investors subscribed in bitcoin or a stablecoin. The offering document should provide for settlement in the fund's reference asset or in kind. The operational controls matter more than the legal power: the receiving wallet has to be verified and screened, the transfer released through the custody approval workflow, and staked or locked tokens dealt with before the dealing day. Since 29 July 2025 the SEC has also permitted in-kind creations and redemptions for bitcoin and ether exchange-traded products, which shows the mechanism is accepted in regulated markets.