NEW YORK–(BUSINESS WIRE)–New research by the law firm Seward & Kissel LLP into the hedge fund industry’s use of side letters—special agreements between hedge funds and their investors—shows a dramatic increase in side letter deals with newer asset managers.

The Seward & Kissel 2016/17 Hedge Fund Side Letter Study, released today, reveals a sharp rise in side letters agreed to by hedge fund managers in business for less than two years. That rate nearly doubled from last year, when Seward & Kissel’s inaugural side letter study put it at 13% of all funds within the study.

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 (17% of side letters) also increased their numbers over last year. 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 significant findings include:

• 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 (SMAs) 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 (23%).

“Our second Side Letter Study has again 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. “The Seward & Kissel 2016/17 Hedge Fund Side Letter Study paints a picture of an investor base that is sophisticated and that is focused on economics and fair treatment.’

 

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