Seward & Kissel Study Reveals Side Letter Usage Rising Among Newer Managers

Sep 14 2017 | 9:31pm ET

A new study by law firm Seward & Kissel on the use of side letters in the hedge fund industry reveals a dramatic increase in the deals amongst newer managers and a clear distinction between those investors who tend to secure them and those who don’t.

Side letters are a form of special agreement between a hedge fund manager and an investor that amend the terms of the fund’s offering terms as a condition of investment. When handled and disclosed properly, they can pave the way for a large investor to come into a fund or seed a new one; when not, they can cause significant headaches for alternative asset managers. 

Seward & Kissel’s study revealed the rate of side letter usage among managers in business for two years or less has more than doubled from last year’s 13% for all funds, the company said in a statement. 

The study also highlighted a growing delta between two investor types most likely to secure side letters: funds of funds accounted for 56% of all side letters, a large leap from last year’s 30%, and wealthy individuals/family offices at 17%. All other fund types – endowments, nonprofits, corporate pensions and government plans – collectively accounted for only 27% of all side letters, down from 56% last year.

Other highlights: 

  • Fee discounts have replaced most-favored-nations (MFN) clauses as the most common term used in side letters. Fee discounts appeared in 49% of side letters, while MFN clauses appeared in 47%.
  • The average regulatory assets under management of managers in the study who have been in business for more than two years was $4.37 billion.
  • The average dollar amount invested via side letters with new managers ($53.65 million) was substantially less than that invested with managers having greater experience ($82.62 million).
  • With a number of investors preferring to invest through separately managed accounts 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%) and family offices.

“Our second Side Letter Study has unearthed valuable insights about where hedge funds are and where they are going,” said Steve Nadel, partner at Seward & Kissel and lead author of the study. “[Our study] paints a picture of an investor base that is sophisticated and that is focused on economics and fair treatment.”

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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