Seward & Kissel Study Shows Hedge Fund Investors Seeking Strong Performance in High Interest Rate Environment

Against a backdrop of elevated interest rates, hedge funds led by new managers are responding to pressure to outperform, according to the 2023 edition of The Seward & Kissel New Manager Hedge Fund Study. Produced annually by the leading law firm to the private fund industry, the Seward & Kissel study reveals a substantial increase in the proportion of new managers launching with an incentive allocation hurdle, guaranteeing investors a baseline return before the manager takes a performance allocation. The full study is available here.

The share of new funds offering incentive allocation hurdles reached 40% in 2023, up from just 15% in 2022. This shift indicates investor demand for strong returns at a time when a risk-free interest rate remains an attractive alternative. However, investors accepted reduced liquidity in exchange, continuing a trend first highlighted in the study’s 2022 edition. In 2023, 78% of equity funds and 71% of non-equity funds employed lock-ups (prohibiting investors from withdrawing capital for a stated term) or investor level gates (restricting the amount an investor may redeem at any given time), up from 69% of equity funds and 67% of non-equity funds in 2022.

In addition to securing greater breathing room through liquidity restrictions, less than half of new managers in 2023 avoided offering reduced management fees or incentive allocation rates through their founders classes. Just 49% of equity funds (down from 59% in 2022) and 47% of non-equity funds (down from 53% in 2022) offered such breaks, suggesting investors’ willingness to trade management fees for the security of a hurdle.

Other key findings of The Seward & Kissel New Manager Hedge Fund Study include:

• There was a sizeable increase in the minimum initial investment requirement for 3(c)(7) equity funds, averaging about $2 million in 2023 (up from $1.35 million in 2022). Conversely, the minimum initial investment requirement for non-equity strategies fell from $2.5 million to $1.5 million.
• Family office participation in hedge fund seeding transactions ticked up in 2023, building on the reentry into the seeding arena for these investors post-pandemic. However, institutional investors continued to account for the vast majority of seed investments.
• Seed investment ticket sizes often exceeded $75mm, continuing a trend of increasing check sizes from seed investors.

Commentary

Seward & Kissel Investment Management Group partner Noelle Indelicato, the lead author of The Seward & Kissel New Manager Hedge Fund Study:

“2023 was a year for performance. With investors less inclined to take risk in a high interest rate environment, we saw new managers turn to incentive allocation hurdles to give investors the security they demanded.”

“Interestingly, fund terms regarding fees and liquidity in 2023 were largely similar to those of 2018. It was a tumultuous five years, but these terms reflect the return of markets to pre-pandemic levels of stability.”

“The strong stock market performance in 2023 seems to have privileged new managers of equity funds, allowing them to set high minimum initial investment requirements — overtaking their non-equity peers.”

Noelle Indelicato is available to speak to the media about The Seward & Kissel New Manager Hedge Fund Study. The survey methodology and full report can be accessed here.

About Seward & Kissel LLP

Seward & Kissel LLP, founded in 1890, is a leading U.S. law firm with an international reputation for excellence. The firm is particularly well known for its hedge fund and investment management work, having established the first hedge fund ever, A.W. Jones, in 1949, and having earned numerous best in class awards over the years. In addition, Preqin recently identified Seward & Kissel as the top U.S. law firm based on number of hedge funds serviced.

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