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New hedge fund managers adopting incentive allocation hurdles

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An increasing proportion of new hedge fund managers are launching with an incentive allocation hurdle, guaranteeing investors a baseline return before the manager earns a performance fee, according to the 2023 edition of the Seward & Kissel New Manager Hedge Fund Study.

The share of new funds offering such hurdles reached 40% in 2023, up from just 15% in 2022. According to Seward & Kissel, this shift indicates investor demand for strong returns at a time when a risk-free interest rate remains an attractive alternative, although they are increasingly being asked to accept reduced liquidity in return – a trend first highlighted in the study’s 2022 edition.

In 2023, 78% of equity funds and 71% of non-equity funds employed lock-ups – prohibiting investors from withdrawing capital for a stated term – or investor level gates – restricting the amount an investor may redeem at any given time – up from 69% of equity funds and 67% of non-equity funds in 2022.

In addition to securing greater breathing room through liquidity restrictions, less than half of new managers in 2023 avoided offering reduced management fees or incentive allocation rates through their founders classes. Just 49% of equity funds (down from 59% in 2022) and 47% of non-equity funds (down from 53% in 2022) offered such breaks, suggesting investors’ willingness to trade management fees for the security of a hurdle.

The study also reveal that there was a sizeable increase in the minimum initial investment requirement for equity funds, averaging about $2 million in 2023 – up from $1.35m in 2022. Conversely, the minimum initial investment requirement for non-equity strategies fell from $2.5m to $1.5m.

Family office participation in hedge fund seeding transactions meanwhile, ticked up in 2023, building on the reentry into the seeding arena for these investors post-pandemic. However, institutional investors continued to account for the vast majority of seed investments, with ticket sizes often exceeding $75m, continuing a trend of increasing cheque sizes.

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