By Steve Nadel (lead author), Partner Seward & Kissel Investment Management Group
Introduction & Key Findings
Driven by our ongoing commitment to understanding the dynamics of the hedge fund marketplace, each year Seward & Kissel conducts The Seward & Kissel New Hedge Fund Study of newly-formed hedge funds sponsored by new U.S.-based managers entering the market. This Study covers the 2014 hedge fund launches of relevant Seward & Kissel clients meeting the above criteria. We believe that the number of funds within the Study is large enough to extract a representative sample of important data points that are relevant to the hedge fund industry. The Study analyzed investment strategies, incentive allocations/management fees, liquidity and structures, as well as whether any form of founders or seed capital was raised. The Study did not cover managed account structures or “funds of one” that may have a wider variation in their fee arrangements and/or other terms.
The Study’s key findings, set forth in greater detail below, include the following:
- 73% of the funds had equity or equity-related strategies (up from 65% in the 2013 Study).
- Incentive allocation rates continued to be set at 20% of net profits across all strategies.
- The past disparity in management fee rates between equity and non-equity strategies was essentially eliminated and averaged out at about 1.7%.
- 81% of funds permitted quarterly or even less frequent redemptions (as compared to 89% in 2013), while 19% of funds permitted monthly redemptions in 2014 (as compared to 11% in 2013). Moreover, as in 2013, 85% of all funds had some form of lock-up or gate.
- Sponsors of both U.S. and offshore funds set up master-feeder structures over 95% of the time, generally utilizing the Section 3(c)(7) exemption. Most offshore funds were established in the Cayman Islands, although other jurisdictions (e.g., Bermuda) began to reestablish their presences in the industry.
- No fund within the Study chose to go down the path of engaging in general solicitations and advertising as is now permitted under Securities Act Rule 506(c) promulgated pursuant to the JOBS Act.
- 65% of funds within the Study (as compared to 43% in 2013) obtained some form of founders capital and, we estimate, based on conversations with various industry participants, that within the entire hedge fund industry, for calendar year 2014, at least 40% of all launches greater than $75 million (and an estimated 15% of all fund launches) had some form of seed capital.
- About 72% of the funds (as compared to 62% in 2013) offered lower incentive allocation and/or management fee rates either to investors who agreed to greater than one year lock-ups (typically represented in the offering documents by different fund series, classes or sub-classes, or sometimes evidenced in a side letter) or to “founding” type investors (that may not have necessarily been tied to longer liquidity). Longer lock-up classes were present in 23% of the funds (which was slightly higher than 19% in 2013). Founders classes (about 20% of which also had a longer lock-up provision for founders) were found in 65% of all funds (up significantly from 43% in 2013).
- Typically, the founders classes on average had a management fee rate that was about 50 basis points less than the management fee charged in the flagship class (which represents 20 basis points more of a differential than in 2013), and they had an average incentive allocation of 15.51% (a slight dip from the 16.1% average in 2013).
81% of funds permitted quarterly or even less frequent redemptions, while 19% of funds permitted monthly redemptions in 2014 (as compared to 11% of funds in 2013). Notice periods were usually 30, 45 or 60 days, however, about 15% of funds required 90 days’ notice.
|soft lock-up (usually, one year with a 2%-4% redemption fee payable to the fund)||
|hard lock-up (usually, one year and non-rolling)||
|an investor-level gate||
|no lock-up or gate of any sort||
*In the flagship class of the fund
Founders or Seed Capital
Given the still rather challenging capital raising environment that existed in 2014, it is not surprising that 65% of funds within the Study (significantly higher than the 43% in the 2013 Study) obtained some form of founders capital and, we estimate, based on conversations with various industry participants, that within the entire hedge fund industry for calendar year 2014, at least 40% of all launches greater than $75 million (and an estimated 15% of all fund launches) had some form of seed capital.
With respect to seed deals, of the funds we studied, the 2014 environment saw a number of new prominent firms enter the seeding arena, as well as the emergence of some smaller opportunistic one-off investors such as certain high net worth individuals (acting alone or collectively through club deals) and family offices. For more prominent managers who were in high demand, the increase in the number of seeders sometimes translated into more favorable deal terms such as scaling down or reduced revenue shares, better buyout multiples, more attractive working capital arrangements and other beneficial provisions. Seed investments in many of the bigger deals remained in the $75 million to $200 million range, typically including a two to three year lock-up. For the smaller deals, usually with less well-known managers, the seed amounts generally ranged from $10 million to $50 million.
This is an extract from the Study. The whole Study is available from this link.