A dramatic reshaping of the hedge fund landscape continued in 2017, as the percentage of new funds employing equity-based strategies fell significantly for the second year in a row, according to the Seward & Kissel 2017 New Hedge Fund Study.
Since 2015, when eight out of 10 new hedge funds used equity-based strategies – a record high in the Seward & Kissel Study – that share has now fallen to just 56 per cent, the lowest level since the Study’s inception in 2011.
The 2017 study marks the first time since 2011 that the number of non-equity-related funds has approached parity with equity-based funds. In a trend first observed last year, as the demand for non-equity funds increases, many of the managers of such funds have moved to lock in capital quickly, mainly by granting management fee and incentive allocation concessions to their early investors, similar to those previously offered by equity-based funds. For example, in one striking finding, the percentage of non-equity funds that offered discounted management fees and/or incentive allocation rates to their founders class investors more than doubled from 36 per cent in 2016 to 75 per cent in 2017.
According to the study average management fees in standard (non-founders) classes held stable at 1.52 per cent for equity strategies and ticked up from 1.43 per cent to 1.61 per cent for non‑equity strategies.
Incentive allocation rates in standard classes decreased across all strategies by about 75 basis points to an average of around 19.25 per cent of annual net profits.
Lock-ups or investor level gates were used by just 66 per cent of the non-equity funds, as compared to 91 per cent of the equity funds (27 per cent of which instituted both lock-ups and gates).
Additionally, beyond the 2017 Study, historical data looking back five years to the 2012 study suggests that new managers are becoming increasingly strategic with their terms. Between 2012 and 2017, managers made significantly more frequent use of founders class incentives to entice day one investments, while at the same time managing portfolio risk through greater use of quarterly liquidity, gates and/or lock-ups. In 2017, 68 per cent of all funds offered management fee discounts and/or incentive allocation rates to founders classes (a jump of 23 percentage points from 2012 to 2017), 80 per cent offered quarterly or worse liquidity (up 16 points from 2012), and 83 per cent included a gate or lock-up (up 10 points from 2012).
Seward & Kissel Investment Management Group partner, Steve Nadel (pictured), the lead author of the study, says: “The pendulum swing towards non-equity funds and away from long/short equity-based funds keeps going. We believe this is primarily attributable to the strong long-biased bull run we have seen. It will be interesting to see whether a correction in equity prices due to rising interest rates and other macro factors will turn the tide.”
“Popularity doesn’t come without a price. With non-equity funds opening at a much higher rate, it is not surprising that larger numbers of them are offering incentives to attract investment.”
“With seven years of data, we can now observe long-term shifts like the increasing prevalence of founders class incentives, quarterly liquidity, and gates or lock-ups – which collectively make it more attractive for money to enter funds in a way that creates greater stability for the investment manager.”
“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.”
