iStock.com / gudella
Hedge fund managers have been focusing on differentiation in order to be competitive, attract the right investor base and stay in the game. Managers are having to adapt to the increasing demands and expectations of investors, as Georgia Prinsloo of Global Funds Management explains.
Large managers are launching more funds of one and managed accounts where bespoke tailoring is the norm. Sometimes customisation takes the form of establishing a new fund based on the specific needs and requirements of a large investor but who still wants the fund established as a commingled vehicle. There is also more movement of investors across fund products within a manager’s platform.
We have seen investors decide they want more customised versions of the strategy they are invested in. For example, we have recently seen large investors wanting a higher volatility version of the fund they were invested in move into a new vehicle set up by the same manager to meet the investor’s requirements—but as a commingled fund.
In terms of new launches we have noticed an increase in US managers using Cayman limited partnerships as master funds. This often involves a structure of a Cayman limited company or limited partnership as feeder and a Delaware limited partnership as onshore feeder.
In terms of independent governance this is still achieved through the appointment of a master fund governance/review committee comprised usually of the same individuals as the board—most commonly two independents (often from different firms) and one from the manager.
Oversight on demand
Independent oversight at the onshore feeder level is also on the rise, usually as a result of seed/strategic investor demand. There is more flexibility with a limited partnership structure as to the role the governance/review committee will play, and so it is essential for the independent directors/committee members to get involved in the discussion around this pre-launch and to offer insights into best practices and the expectations of investors in 2018 and beyond to ensure the fund launches with the best governance terms.
We often speak with prospective investors pre-launch as part of their due diligence procedures and this is a good opportunity to hear what is important from their perspective and to discuss our approach to fund governance. Investors increasingly have a large say in how a fund is set up and we welcome that open dialogue and relationship, which is very much part of the new landscape.
For Canadian launches, the structuring is somewhat more complex and the preference for independence in a Cayman limited partnership context is the appointment of a majority independent Cayman general partner board and then also governance/review committees for certain funds.
The inclusion of an investment advisory committee is something we have also noticed in a few new fund launches. This usually consists of industry leaders as a resource for the manager to advise with respect to such matters as investment opportunities, macro and industry trends and business and strategic decisions.
We have also noticed an increase in interest for independent governance in private equity funds, a trend we expect to continue particularly given the increasing regulatory compliance burden in this sector. In terms of structuring in a private equity context, we have most recently seen the use of the new Cayman limited liability company vehicle with the independent directors forming the managing board member.
We have also been appointed to the board of Delaware limited liability companies as a result of investor preference for independent governance. Another trend has been an increased awareness of environmental and social governance matters across some fund platforms.
Having sufficient capacity, diversity of qualifications, skillsets and experience is increasingly sought after when considering the ideal composition of fund boards and the ‘split board’ model of having independent directors from different firms is very much entrenched.
The fund terms landscape
Successful launches tend to have a seed, strategic or anchor investor and for emerging managers without a track record it is increasingly more difficult to have firm commitments ahead of the launch date. To attract investors to allocate at an early stage, managers have had to be more thoughtful and creative about their terms and hedge fund arrangements are becoming increasingly dynamic.
In terms of capacity rights, we have seen restrictions both at an investor level and at certain fund assets under management (AUM) levels, so that investors know when the manager will take a pause in accepting new capital. This arguably creates a ‘buzz’ around the launch and allows the fund to grow at a steady and controlled pace which is often well received by investors.
We have been seeing fee structures offered that are better aligned with investors’ objectives in an effort to attract capital and build a long-term partnership with investors. Lower fees are often offered for a longer lock-up period or larger allocation size. We have also seen fee arrangements with management fees that decline as AUM grows, and sometimes with more than one trigger on that reduction.
We have also seen this type of AUM-triggered reduction offered on performance fees/incentive allocation although this is less common. Some funds are also offering a larger range of options regarding performance fees, for example a range of different fees with a high water mark (less than 20 percent) and then a range with higher fees (over 20 percent) for net capital appreciation for performance in-excess of certain hurdle rates.
New fund launches are also often including some of the more common ‘side letter’ asks into the offering document, to obviate the need to negotiate such terms. We have noticed a trend as regards side letters for most favoured nation clauses to cover the manager’s other products including their managed accounts. An important consideration for us as directors is whether by entering into a new side letter, are any existing investor rights triggered under their side letters (which may cover investors in other funds) and ensuring notification is provided when required.
We also focus on some of the more commercial aspects of side letters, what terms should be offered to all investors and considerations for best practices.
As allocators look for managers with an edge and a differentiated offering, we have seen increased interest in certain strategies such as those employing a quantitative approach. We have also seen managers in traditional long/short shops employing a quantitative overlay to their process. There is also interest in more hybrid hedge/private equity type products uncorrelated to the markets.
We have seen in some recent launches particularly in Asia the concept of private investment shares for pre-IPO type opportunities and other unlisted or unquoted securities with investors being given the opportunity at subscription to elect in or out of this share class.
As directors with experience across a multitude of funds with different strategies and at different stages of their life cycle, we are able to offer constructive insights into best practice and market standard when it comes to the terms of the fund offering, particularly in the area of board authorities versus what is delegated to the manager. There are matters that are appropriate to delegate to the manager and we have a flexible approach on this.
As the funds world is very dynamic and fast paced, we as directors need always to be available and ready to step in and be fully engaged with whatever issue we are confronted with, including in times of possible market distress. We are encouraged by the current landscape and the better alignment of interests and are optimistic about the health and continued growth of our industry here in the Cayman Islands and globally.
Georgia Prinsloo is a principal of Global Funds Management. She can be contacted at:
Hedge funds, investors, managers, governance, Cayman, landscape, investment