New research by the law firm Seward & Kissel into the hedge fund industry’s use of side letters – special agreements between hedge funds and their investors – shows a dramatic increase in side letter deals with newer asset managers.
The Seward & Kissel 2016/17 Hedge Fund Side Letter Study reveals a sharp rise in side letters agreed to by hedge fund managers in business for less than two years. That rate nearly doubled from last year, when Seward & Kissel’s inaugural side letter study put it at 13 per cent of all funds within the study.
The study also highlighted a growing delta between two investor types most likely to secure side letters: funds of funds accounted for 56 per cent of all side letters (a large leap from last year’s 30 per cent), and wealthy individuals/family offices (17 per cent of side letters) also increased their numbers over last year. All other fund types – endowments, nonprofits, corporate pensions and government plans – collectively accounted for only 27 per cent of all side letters, down from 56 per cent last year.
According to the study, fee discounts have replaced most-favoured-nations (MFN) clauses as the most common term used in side letters. Fee discounts appeared in 49 per cent of side letters, while MFN clauses appeared in 47 per cent.
The average regulatory assets under management of managers in the study who have been in business for more than two years was USD4.37 billion., while the average dollar amount invested via side letters with new managers (USD53.65 million) was substantially less than that invested with managers having greater experience (USD82.62 million).
With a number of investors preferring to invest through separately managed accounts (SMAs) rather than hedge funds, the study also tracked SMAs in 2016-17. As with side letters, SMAs were most likely to be executed with funds of funds (69 per cent) and family offices (23 per cent).
“Our second Side Letter Study has again unearthed valuable insights about where hedge funds are and where they are going,” says Steve Nadel (pictured), partner at Seward & Kissel and lead author of the study. “The Seward & Kissel 2016/17 Hedge Fund Side Letter Study paints a picture of an investor base that is sophisticated and that is focused on economics and fair treatment.”
