HF managers grow via hybrid strategies

According to law firm Seward & Kissel’s annual New Hedge Fund Study, the industry is experiencing greater investor interest as the pandemic struggles seem to wane.

Seward & Kissel found that institutional seeders remained fairly active and accounted for the vast majority of seed investments in 2021. Terms of seed investments were broadly consistent with historical observations, and seed capital investment sizes were typically over $50 million, which is consistent with historical practices for institutional seeders.

Yet, a new trend has fully entrenched itself in the industry: hybrid offerings that blur the lines between alternatives strategies, particularly when it comes to funds being seeded. The research revealed a number of seed investments in healthcare focused managers that often had a sizable allocation of their portfolios in illiquid investments — usually these funds were structured as hybrid funds or with unusually large side pocket tolerances.

“The strong appetite among seeders for hybrid fund structures is unsurprising given the increasing conversations we are having with both new and established managers about “hybrid” or public or public/private products today,” said Nick Miller, partner in Seward & Kissel’s Investment Management Group and lead author of the study. “We expect hybrid structures generally to continue as a growing trend in 2022, as well as investments targeting industries such as healthcare, tech, and digital assets, all of which we’ve seen significant interest in in the new launch space this year.”

In 2021, the larger tickets for seed investment deals remained in the $50 million to $100 million range, typically including a two- to three-year lock-up. The law firm’s data suggest that deferrals of seeder economics can become a means of making more working capital available to new managers and continues to be increasingly common in seed deals, which is broadly consistent with what Seward & Kissel has observed for the past several years. Interestingly, the duration of the revenue share remains perpetual in the vast majority of these investments.

Of the new funds launched last year, 70% were equity or equity-related strategies, which is up from 66% in 2020. Equity funds were more apt to offer a founders share class too with 57% of new funds doing so, while only 50% of non-equity fund launches did.

The law firm’s work with new funds, managers and structures dates back to 1949, when it worked to establish the first hedge fund — A.W. Jones.

The firm’s review of newly launched hedge fund managers last year, found that active participants were eager to take advantage of recent market opportunities.

This corresponded with greater demand for hedge funds along with a new trend of resistance against fee compression, which has been a consistent trend in the industry since the global financial crisis. The firm found that for hedge fund strategies management fees for equity funds held steady in 2021 at 1.52%, up from 1.51% in 2020. The management fee rose slightly for non-equity strategies to 1.66%, up from 1.52% in 2020.

Notably, the share of funds with incentive allocation hurdles grew to 21%, which is up from 10% in 2020. Incentive allocation rates in standard classes across all strategies averaged 20% of annual net profits, which is up slightly from 19% in 2020. This is while the percentage of equity funds with lock-ups or gates decreased.