The percentage of side letters executed with ‘mature’ hedge fund managers has risen to the highest level seen in eight years, according to the latest edition of an annual study by financial services law firm Seward & Kissel.
The authors of the firm’s eighth annual Hedge Fund Side Letter Study attribute the large and growing disparity between the share of side letters issued by mature and new managers, in part, to the challenging fundraising environment facing newer funds.
According to the 2022/23 Hedge Fund Side Letter Study, 84% of side letters – special agreements between hedge funds and their investors – were signed with mature managers, defined in the study as those in business for two or more years. That figure, up from 78% last year, represented the highest level since 2015-16, when mature managers accounted for 87% of side letters.
Other findings in the study align with the conclusion that difficult fundraising conditions disproportionately affected newer managers and smaller funds. Most markedly, the size of funds executing side letters increased dramatically, suggesting an investor appetite for larger and more established managers. The average regulatory assets under management of funds signing side letters jumped from $4bn last year to approximately $7bn this year. The average RAUM for newer managers in the study, meanwhile, fell from $210m to $170m.
With the increased representation of mature managers, who are often less willing to negotiate business terms, the five principal business terms tracked by Seward & Kissel—including most – favoured-nation clauses, fee discounts, and capacity rights – all appeared in a smaller share of side letters this year as compared to last year.
The survey also found that the most popular business term in side letters for the last two years, most-favoured-nation clauses, appeared in 33% of side letters, down from 46% last year.
Funds-of-funds meanwhile, accounted for 54% of all side letter investors, continuing a long upward trend since 2015-16, when they accounted for 30%, while corporate and public pensions executed side letters exclusively with mature managers.
