A growing number of new hedge funds offered by US-based managers implemented management fee structures that decrease as fund assets grow, according to a new study by Seward & Kissel.
The law firm’s latest annual hedge fund study reveals that hedge fund managers’ are demonstrating heightened sensitivity to the needs of investors, and the related imperative to reign in costs. Of all funds studied, 19% adopted a tiered approach to management fees, stepping down to lower rates as assets in the fund surpass pre-established benchmarks. (Seward & Kissel estimates this figure was less than 10% in 2013.) The tiered management fee structure recognises and accounts for the efficiencies that can be gained with scale.
All of the funds employing the tiered management fee structure had equity-related strategies, raising the question of whether the trend will spill over into funds with non-equity strategies in future years. In addition, the percentage of all funds using equity strategies increased to 73% in 2014, up from 65% in 2013.
Improved operational efficiencies among hedge funds that employ non-equity-based strategies likely contributed to another finding: the virtual elimination in any disparity between the management fees charged by equity- and non-equity-based funds. The average management fee rate charged by non-equity-based funds decreased 12 basis points in 2014, with the rate across all funds converging at 1.7%.
Other figures from the study suggest that in 2014, managers were very focused on raising day one capital and, consequently, offered founders class fee discounts a high percentage of the time. The percentage of all funds that obtained some form of founders capital increased sharply, from 43% in 2013 to 65% in 2014, with 75% of equity funds and only 43% of non-equity funds offering such classes.
Other key findings of the study include:
• 81% of funds permitted quarterly or even less frequent redemptions (as compared to 89% in 2013), while 19% of funds permitted monthly redemptions in 2014 (as compared to 11% in 2013). Moreover, as in 2013, 85% of all funds had some form of lock-up or gate.
• Incentive allocation rates continued to be set at 20% of net profits across all strategies.
• Seward & Kissel estimates, based on conversations with various industry participants, that within the entire hedge fund industry for the calendar year 2014, at least 40% of all launches greater than $75 million (and an estimated 15% of all fund launches) had some form of seed capital.
• Sponsors of both US and offshore funds set up master-feeder structures over 95% of the time, generally utilizing the Section 3(c)(7) exemption. Most offshore funds were established in the Cayman Islands, although other jurisdictions (e.g., Bermuda) began to reestablish their presences in the industry.
• No fund within the study chose to go down the path of engaging in general solicitations and advertising as is now permitted under new Securities Act Rule 506(c) promulgated pursuant to the JOBS Act.
Seward & Kissel Investment Management Group partner, Steve Nadel (pictured), the lead author of the Seward & Kissel New Hedge Fund Study, says: “This much is clear from the 2014 Study: it’s more important than ever for managers to run a tight ship. The increased adoption of trickle-down management fees tells us that managers are listening to an investor attitude that as you get larger, you should be sharing your economies of scale with your clients.
“The greater percentage of equity-based funds may reflect the fact that equity strategies outperformed many other investment strategies in 2014.
“For new managers and those in the early stages of launching a fund, The Seward & Kissel New Hedge Fund Study provides practical intelligence on their peers, as well as on the demands being made by investors.”
