More non-equity hedge funds offer founders' shares to help boost new launches
More non-equity hedge funds are offering founder share classes in a bid to attract capital and get new launches off the ground.
Law firm Seward & Kissel’s annual ‘New Hedge Fund Survey’ questioned US-based hedge fund managers established in 2020, probing their investment strategies, incentive allocations and management fees, and liquidity and structures, among other things.
Amid soaring volatility and continued market stress across asset classes, the study noted the barriers faced by hedge fund managers in raising capital, with allocators tending to stick with larger, established managers and existing relationships during the pandemic.
“However, as time has passed and ‘work-from-home’ continues to be the ‘new normal’, allocators have begun to expand their perspectives and are becoming more accepting of a wider pool of managers,” the report observed.
Against that backdrop, more and more hedge funds are now offering lower management fees or reduced incentive allocation rates (or both) in founding share classes to tempt initial investors.
More than half (53 per cent) of the equity funds surveyed offered lower management fees and/or incentive allocation rates through founders’ share classes (an increase on the 47 per cent in 2019’s study). An even larger share of non-equity funds – 60 per cent – took similar measures, a sharp rise from 38 per cent the previous year.
The average founders class management fee fell from 1.23 per cent in 2019 to 1.18 per cent in 2020 for equity funds. The average for non-equity funds was 1.28 per cent, up slightly from 1.25 per cent in 2019. The average founders class incentive allocation was 13.86 per cent for equity funds (down from 15 per cent in 2019), while the average for non-equity funds was 15.39 per cent (down from 15.67 per cent in 2019).
Overall, equity-based hedge funds – traditionally the dominant strategy type within the industry – continue to comprise the bulk of new products launched, accounting for 66 per cent of all funds examined by the study (down from 70 per cent in 2019). The remaining 34 per cent non-equity strategies were split among multi-strategy, quantitative, global macro, credit and commodity-related hedge funds.
As a result, management fees for standard non-founder classes in equity-based hedge funds has increased from an average of 1.43 per cent in 2019 to 1.51 per cent last year, as sustained investor demand has helped curb fee compression.
However, non-equity-based fund managers have lowered their standard management fees, from an average of 1.68 per cent to 1.52 per cent over the same period, to try and pull in more allocator money.
Meanwhile, incentive allocation rates in standard classes across all strategies averaged 19 per cent of annual net profits, virtually the same as in 2019, the study observed.
Steve Nadel (pictured), partner in Seward & Kissel’s Investment Management Group and lead author of the study, said despite the widespread upheaval wrought by the Covid-19 pandemic on hedge funds, there was a “fair degree of consistency” with previous years’ surveys.
“We saw relatively stable numbers, for instance, in incentive allocation rates, lock-ups, and the share of funds using equity-based strategies,” Nadel said.
Nadel told Hedgeweek that equity funds’ demand continued to remain strong, while non-equity funds did various activities to compete better in 2020, as founders’ capital proved “much harder to come by” last year.
“The fact that investors could not conduct on-site due diligence during most of 2020 had a dramatic impact on capital raising beyond merely lengthening the sales cycle. As in other industries, the biggest players were at a great advantage, but that effect has eroded and new entrants seem to have gained a foothold.”
Elsewhere, the report found that lock-ups or investor-level gates were used by 79 per cent of the equity funds and 70 per cent of the non-equity funds, with 5 per cent of all funds including both.