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Vast disparity in types of investors securing side letter arrangements

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Funds-of-funds entered into side letters – special agreements that hedge fund managers sometimes make with investors, overriding general terms applicable to other investors – six times as often as non-profit institutions and nearly four times as often as corporate pension funds.

That’s according to the Seward & Kissel 2015/16 Hedge Fund Side Letter Study, which reveals that funds-of-funds made up 30.5 per cent of all side letter investors and government plans 27.1 per cent.
The investor types with the fewest side letters were corporate pensions and non-profit institutions, making up only 8.5 per cent and 5 per cent of all side letter investors, respectively.
Additionally, the most common side letter business term was the most favoured nations (MFN) clause, which appeared in 56 per cent of all side letters included in the study. Nearly 90 per cent of side letters with wealthy individuals, family offices, and endowments included MFN clauses. However, MFN clauses were less frequent in side letters signed with funds-of-funds and non-profit institutions, appearing only 33 per cent of the time.
The Seward & Kissel 2015/16 Hedge Fund Side Letter Study analysed side letters extended from hedge fund managers who have been in business for at least two years, and the average regulatory assets under management (RAUM) of such managers was USD4.5 billion.
The study found that 97 per cent of MFNs contained a bundling concept providing that if a preferential term is given to another investor contingent upon a less favourable term, the MFN holder would have to accept the bundle of rights, and cannot select just the favourable term.
After MFNs, the second most common side letter term involved fee discounts, which were present in approximately 40 per cent of side letters included in the study, but in only 20 per cent with managers over USD1 billion in RAUM. Moreover, only one half of the side letters that included fee discounts gave them on both the management fee and the incentive allocation.
Only 6.8 per cent of side letters offered preferential liquidity, and none of those were with managers having more than USD1 billion in RAUM.
“The breadth of our practice continues to provide us with important thought leadership data points,” says Steve Nadel (pictured), partner at Seward & Kissel and lead author of the study. “The Seward & Kissel 2015/16 Hedge Fund Side Letter Study gives us insight into an important aspect of the hedge fund industry that hasn’t been subject to this type of analysis before. The disparity in the number of side letters extended to different investor types and the frequency of the business terms given are among the eye-opening findings of this initial study.”

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