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Rise of Non-Equity Funds Is Hedge Fund ‘Story of 2016’: Seward & Kissel

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Thirty-five percent of hedge funds rolled out last year employed non-equity-based investment strategies, up from 20% in 2015, according to a new study by Seward & Kissel, a law firm.

“The rising popularity of non-equity-based funds is the story of 2016,” Steven Nadel, the study’s lead author, said in a statement. “New fund managers obviously reacted to a big shift in investor appetites.”

The study found that as non-equity funds become more prevalent, investors are beginning to demand concessions from them similar to those they previously received from equity-based funds.

Thirty-six percent of non-equity funds launched in 2016 offered special “founders” terms to investors, compared with 29% of new funds in the 2015 report. Founders classes generally require a higher minimum investment.

In contrast, equity funds with founders classes went the other way, with 75% making these offers, down from 82% that did so in 2015.

The study showed that management fees charged to standard class members by both equity and non-equity funds were down last year: to 1.51% and 1.43%, respectively.

And whereas no non-equity-based funds offered tiered management fees in their founders classes in 2015, 25% of them did so in 2016. As well, 40% of equity funds offered tiered management fees last year, up from a mere 5% in 2015.

Tiered management fees go down as fund assets rise, in recognition of efficiencies of scale, the study said.

And in what Seward & Kissel called “a very hot trend to keep an eye on going forward,” 20% of equity funds with founders classes used a tiered incentive allocation in 2016. In the previous year’s study, only a single fund did so.

New research released by Citco and HFM Global found that 72% of hedge fund managers were implementing new fee structures in response to investor pressure.

Other Findings

In 2016, 40% of managers in the Seward & Kissel study launched a U.S. fund without also offering an offshore fund, up from 25% in 2015.

The firm said this was the newest evidence of a trend that began in 2012, in which managers first establish a track record with a U.S. fund before leveraging it to attract offshore investors.

In another finding, 94% of new funds allowed investors to make redemptions on a quarterly or shorter basis. At the same time, all funds in the study imposed some form of lockup, allowing them to hold investor assets for a minimum period of time, or investor-level gate, which puts a lid on the amount that can be redeemed at one time.

And new hedge funds found seed investors harder to attract in 2016. Seward & Kissel estimated that between 25 and 30 seed deals were executed in 2016, down 25% from 2015.

For bigger deals, seed amounts were in the $75 million to $200 million range, typically including a two- to three-year lockup. For deals with less well-known managers, seed amounts generally ranged from $10 million to $50 million, often with a two-year lockup.

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

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

— Check out Liquid Alts Trailed Hedge Funds in February on ThinkAdvisor.