New Study Shows Sharp Rise In Non-Equity Based Strategies Among New Hedge Funds

Mar 14 2017 | 11:29pm ET

A rising number of newly launched hedge funds are employing non-equity-based investment strategies, according to a new study released by law firm Seward & Kissel.

The firm’s annual New Hedge Fund Study surveys U.S.-based funds that were set up in 2016 and identifies key trends within the new hedge fund industry. 2016’s analysis indicate that as non-equity funds become more prevalent, investors are beginning to extract from them concessions similar to those they have previously won from equity-based funds, the company said. 

Highlights of the Seward & Kissel 2016 New Hedge Fund Study:

The portion of new hedge funds using non-equity-based strategies increased to 35% in 2016, up from 20% in 2015.

The percentage of non-equity funds offering special “founders” terms to investors jumped from 29% in 2015 to 36% in 2016, while the percentage of equity funds with such “founders classes” dropped from 82% to 75% over the same period.

Management fees charged to standard class members were down from last year, both for non-equity funds (1.43%) and equity funds (1.51%). Most strikingly, while not a single non-equity-based fund offered tiered management fees in their founders classes in 2015, 25% of them did in 2016. Tiered management fees (which step down as fund assets grow, in recognition of efficiencies of scale) were offered by 40% of equity funds this year, up just 5% from last year.

The percent of managers who launched a U.S. fund without also offering an offshore fund rose to 40% in 2016, up from 25% in 2015. This is the latest and most dramatic evidence of a trend that began in 2012, in which managers are first establishing a track record with a U.S. fund, and leveraging it to attract offshore investor interest later.

There was little deviation among funds with regard to liquidity-related terms. Nearly all funds - 94% - permitted investors to make redemptions on a quarterly or shorter basis. Balancing that permissive approach to redemption frequency, every fund in the study imposed some form of lock-up or investor level gate. 

After a single fund introduced a tiered incentive allocation last year (which was a first for The Seward & Kissel New Hedge Fund Study), 20% of equity funds with founders classes used a tiered incentive allocation in 2016, a trend that bears watching. 

Seward & Kissel estimates that a total of 25-30 seed deals were executed in 2016, down 25% from 2015. 

“The rising popularity of non-equity-based funds is the story of 2016,” said Seward & Kissel Investment Management Group partner Steve Nadel, lead author of the 2016 study. “ New fund managers obviously reacted to a big shift in investor appetites.  

“Certain trends accelerated very rapidly this year, including the practice of starting U.S. standalone funds without offshore counterparts and employing tiered incentive allocations. 

“Meanwhile, it’s notable that the funds in the Study were unanimous in employing either a lock-up or an investor level gate. Greater information sharing and transparency could be driving a degree of herd behavior,” he added. 

Founded in 1890, Seward & Kissel LLP is a major U.S. law firm particularly well known for its hedge fund and alternative investment management expertise. It was involved in the establishment of A.W. Jones, widely considered to be the first hedge fund, in 1949.

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