New Managers Often Increase Liquidity Restrictions as Portfolios Evolve

Amidst an uncertain economic environment, a new report indicates a continuing shift in portfolio dynamics towards longer-held positions necessitating a tightening of liquidity rules into 2022. The Seward & Kissel New Manager Hedge Fund Study, an annual analysis of new manager hedge funds produced by the leading law firm to the private fund industry, reveals that hedge fund terms regarding withdrawal frequency, investor-level gates, and so-called “hard lock-ups” all trended toward limiting liquidity last year. The full study is available here.

The share of funds limiting withdrawals to a quarterly (or less frequent) basis rose to 91% in 2022, up from 81% five years ago. The increased restriction was most marked among funds employing non-equity strategies. Only 55% of such funds limited withdrawals to a quarterly basis in 2018, while 93% did last year. Other important liquidity terms followed the trend. In 2021, just 21% of all funds employed both investor-level gates (restricting the amount an investor may redeem at any given time) and lock-ups (prohibiting investors from withdrawing capital for a stated term). In 2022, that doubled to 42%. Among standard classes of equity funds, the use of investor-level gates leapt from 18% in 2021 to 60% in 2022.

Interestingly, the trend towards greater liquidity constraints was not, however, as pronounced for more established managers. This year, for the first time, Seward & Kissel—which represents approximately half of the top 100 hedge funds based on assets under management—conducted a parallel study of new funds launched by established investment managers (those with a longer track record and larger AUM). The forthcoming Seward & Kissel Established Manager Hedge Fund Study found that, among other things, quarterly liquidity, as well as soft lock-ups and/or gates was present in about 25% of the funds with traditional hedge fund strategies, and was even less restrictive among short-term income-focused bespoke strategies funds (of which 75% offered monthly liquidity). Besides some strategy differences, Seward & Kissel believes that the liquidity differences between new manager and established manager funds is partly attributable to the fact that the established manager funds are not flagship offerings and therefore their managers are less sensitive about maintaining fund asset levels to run the overall firm.

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

• The share of managers who launched with just a U.S. standalone fund rose to 60%, up from 39% in 2021.
• The share of funds with equity-related strategies rose six percentage points to 76% in 2022, nearing the study’s high-water mark of 80% from 2015.
• Management fees for standard classes declined 10 basis points for funds using equity strategies, to 1.42%.
• In another liquidity-related metric, the average notice period required for withdrawals increased from almost 51 days in 2021 to more than 63 days in 2022.

Commentary

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

“An interesting finding this year was the high percentage of managers launching only in the U.S. That phenomenon in part reflects a strategy among new managers to build a track record first, upon which they can attract offshore and U.S. tax-exempt investor interest in the future and we believe is indicative of the ever-challenging fundraising environment.”

“The recent uptick in investor-level gates and hard lock-ups could be attributable to a particularly high demand for alternative investment strategies with longer liquidity profiles.”

“For new managers and those in the early stages of launching a fund, The Seward & Kissel New Manager Hedge Fund Study provides practical intelligence on their peers, as well as on the demands being made by investors.”

Nick Miller is available to speak to the media about The Seward & Kissel New Manager Hedge Fund Study. The survey methodology and full report are accessible online 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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