In a turbulent historic moment marked by geopolitical strife and inflationary pressures, a new study of the hedge fund industry by Seward & Kissel LLP, a preeminent financial services law firm, reveals that the percentage of side letters executed with mature hedge fund managers has risen to its highest level in eight years. The authors of Seward & Kissel’s eighth annual Hedge Fund Side Letter Study attribute the large and growing disparity between the share of side letters issued by mature and new managers in part to the challenging fundraising environment facing newer funds. The full study can be accessed here.

The Seward & Kissel 2022/23 Hedge Fund Side Letter Study, released today, shows that 84% of side letters—special agreements between hedge funds and their investors—were signed with mature managers, defined in the study as those in business for two or more years. That figure, up from 78% last year, represented the highest level since 2015-16, when mature managers accounted for 87% of side letters.

Other findings in the study align with the conclusion that difficult fundraising conditions disproportionately affected newer managers and smaller funds. Most markedly, the size of funds executing side letters increased dramatically, suggesting an investor appetite for larger and more established managers. The average regulatory assets under management of funds signing side letters jumped from $4 billion last year to approximately $7 billion this year. The average RAUM for newer managers in the study, meanwhile, fell from $210 million to $170 million.

With the increased representation of mature managers, who are often less willing to negotiate business terms, the five principal business terms tracked by Seward & Kissel—including most-favored-nation clauses, fee discounts, and capacity rights—all appeared in a smaller share of side letters this year as compared to last year.

Additional specific findings include:

• The most popular business term in side letters for the last two years, most-favored-nation clauses, appeared in 33% of side letters, down from 46% last year.
• Funds-of-funds accounted for 54% of all side letter investors, continuing a long upward trend since 2015-16, when they accounted for 30%.
• Corporate and public pensions executed side letters exclusively with mature managers.

“Our eighth Side Letter Study has again unearthed valuable insights into the continued evolution of hedge funds and their investors,” said Kevin Neubauer, partner at Seward & Kissel and lead author of the study. “The Seward & Kissel 2022/23 Hedge Fund Side Letter Study demonstrates strategic choices being made by hedge fund managers and their investor base alike.”

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 private fund and investment management work, having established the first private fund firm, 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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