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Hedge fund study reveals more manager-investor equilibrium and a rise in alternative seed deals

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Newly launched hedge funds continued to entice investors with management fee discounts while simultaneously tightening restrictions on redemptions, according to The Seward & Kissel 2015 New Hedge Fund Study.

The 2015 findings reflect a give-and-take between hedge funds and investors. On the one hand, they show the continuation of a trend in which hedge funds are willing to incentivise investors to join their founders classes, offering discounted fees, and sometimes tiered management fees that step down as fund assets grow. On the other hand, hedge funds further tightened their redemption rules.
In 2015, 35 per cent of funds using equity-based strategies offered tiered management fee discounts in their founders classes, as compared to 25 per cent in the 2014 study. The tiered management fee structure recognises efficiencies that can be gained with scale, while incentivising investors to contribute “day one” capital. While this suggests a sensitivity to investor concerns, an increasing percentage of funds allowed investors to make redemptions only on a quarterly or even less frequent basis, with 88 per cent employing such policies in 2015, up from 81 per cent in 2014. Moreover, the percentage of funds implementing some form of lock-up or gate also increased by 3 per cent to 88 per cent in 2015.
The latest study also reveals a new trend with respect to seed deals. In the still-challenging capital-raising environment of 2015, while 68 per cent of new funds launched with some form of founders capital, seed deals also grew in popularity among allocators. Seed deals, which have become prevalent since the recession, historically have been well-publicised transactions involving well-known players. However, based on internal data and conversations with industry insiders, Seward & Kissel estimates that 35 to 45 seed deals – many of them unpublicised, one-off, opportunistic plays by lower profile investors – were executed in 2015.
A trend in which an increasing percentage of hedge funds are employing equity-related strategies continued in 2015. The study found that 80 per cent of funds used equity-related strategies, up from 73 per cent in 2014 and 65 per cent in 2013. The increase has been a major story in the industry over the last three years, and many are keeping an eye on whether this has been driven by uncertainty over the Federal Reserve’s action on interest rates, which could especially impact funds using credit strategies.
Additionally, the pre-existing disparity in management fee rates between funds using equity and non-equity strategies resurfaced again, after nearly vanishing in 2014. Funds with equity strategies imposed management fees about 12 basis points higher than those using non-equity strategies, which reversed the trend of prior years where equity strategies had been lower historically.
Seward & Kissel Investment Management Group partner, Steve Nadel (pictured), the lead author of The Seward & Kissel New Hedge Fund Study, says: “The 2015 study reveals a more even balance of power between hedge funds and investors. More funds found it necessary to lure initial investors with reduced fees, but at the same time, investors understood that many strategies warranted a longer redemption cycle.
“The jury is out on how the Federal Reserve’s historic interest rate increase will impact fund strategies moving forward. However, anecdotally, we’ve begun to see an uptick in debt-driven funds starting in 2016, and we’re hearing chatter in the market that there is an increased appetite for credit-driven strategies.
“For new managers and those in the early stages of launching a fund, The Seward & Kissel 2015 New Hedge Fund Study provides practical intelligence on their peers, as well as on the demands being made by investors.”

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