It is a trend that has steadily gathered momentum over the last five years and one that shows no sign of abating: namely that the big US hedge fund groups continue to get bigger and attract most of the institutional money. Macro managers have been the clear benefactors this year. According to Preqin, approximately USD13.5 billion of the USD25 billion of net inflows for 1H17 went to global macro strategies.
From a structuring perspective, large managers are increasingly choosing to establish funds-of-one to meet the specific needs of US institutional investors.
"Under Cayman law we don't have the managed account concept so a fund-of-one is the preferred structuring option for these managers," explains Joanne Huckle, Partner, Investment Funds Team, Ogier (Cayman Islands). "Institutional investors are becoming more demanding in terms of wanting to tailor their investment needs. One way to do that is to set up a dedicated fund for that investor, to reflect whatever investment terms they are requesting."
These structures are also being used by some US managers to accommodate the needs of European institutions, who might want exposure to a particular strategy, but who prefer to have the safety of a fund-of-one as opposed to allocating into an offshore commingled fund structure.
Huckle says that funds-of-one are similar to feeder funds in that they can be structured underneath a master fund.
"A few of our large managers have a number of master funds and have set up various funds-of-one as feeder funds, which feed into the different master funds depending on the strategy".
"At a wider level, one particular trend we see is Japanese investors, who traditionally have been quite timid investors in hedge funds, becoming more tempted to seek out higher yielding assets as a result of a change in government policy in Japan. US managers recognise this and are setting up structures, sometimes as funds-of-one, to provide an attractive alternative option for Japanese investors," explains Huckle.
While US managers are familiar with companies and partnership fund structures, Japanese investors are more likely to favour Cayman unit trusts. "We've had quite a few US managers this year establishing Cayman unit trusts specifically to attract Japanese institutional investors," confirms Huckle, who adds that another structuring trend involves hedge fund managers launching private equity vehicles."
One approach is to use a hybrid structure, with a core of liquid securities surrounded by a satellite of more illiquid assets (e.g. distressed credit).
"We are seeing more hybrid funds being established, where traditional hedge funds are investing some of the portfolio in assets associated with private equity funds. As a consequence, this requires making structuring changes to the fund. It may look in some respects like a regular hedge fund but it may need the ability to establish side pockets or gates for the illiquid assets," explains Huckle.
The other approach is to establish a fully-fledged private equity structure.
Huckle says that this could be done using a traditional master/feeder structure with a partnership master fund offering two classes of interests and two feeders, one being a partnership vehicle linked to the illiquid investments and the other being a corporate vehicle linked to the liquid investments
Asked what the driver behind this trend might be, she opines that it could stem from a frustration that without having capital locked in, some managers feel they aren't able to generate the returns from the strategy that they would otherwise get.
"They think if they have the opportunity, for a defined term, to grow the investments they can develop a better track record and showcase their investment skills better than they are perhaps able to in the current market (using purely hedge fund structures)," she says.
Most launches to date have been in structured credit, special situations, and structured credit restructuring opportunities.
The obvious benefit to managers willing to be flexible and establish PE-like funds with capital lock-ups is that it automatically creates a stronger long-term alignment of interests with LPs.
"It is a way to avoid kneejerk withdrawals from the fund because of one year of sub-par performance, for example, which then prevents the manager from achieving a better return," concludes Huckle.
Originally published in Hedgeweek.
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