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Walkers Fundamentals White Paper 2020 – Private Equity Part 2

Welcome to Walkers’ 2020 Fundamentals White Paper Series, in which we discuss certain trends identifiable among the hedge funds and private equity funds that we helped our clients launch over the last twelve months.

In last year’s White Paper, published in November 2019, managers and their funds appeared to be positioning themselves for market turbulence in the face of global uncertainties and a volatile economic and financial environment. One year on, with the benefit of hindsight, this was something of an understatement. 2020 has tested all aspects of managers’ businesses, from the boardroom to the back office, and in many parts of the world out of the office altogether. All of this, of course, is not to overlook the broader global context of the pandemic and the significant health, economic and political challenges that 2020 has brought and continues to present.

To visit the other parts of the series, please use the direct links below:

Private Equity Trends Part 2

Among the uncertainty and turmoil of 2020, closed-ended fund formation activity has continued at pace, as managers and their advisers have negotiated side letters, launched funds and continued downstream activity, largely operating in a virtual world. In the Cayman Islands, the enactment of the Private Funds Law has seen Cayman closed-ended funds subject to a registration regime for the first time, with existing and newly launched private funds required to provide certain registration information to the Cayman Islands Monetary Authority (“CIMA”). Private funds will also be required to comply with ongoing obligations with respect to operational matters such as audit, safekeeping of assets, valuations and cash monitoring, which obligations largely codify existing best practices familiar to most managers domiciling their funds in the Cayman Islands.

The new regime ensures that the Cayman Islands remains the offshore financial centre of choice for global fund managers launching closed-ended funds, and supports the Cayman Islands’ broader aim of adopting global standards in areas such as anti-money laundering and economic substance.

FUND DURATION

8 - 10 years remains the most common term generally, with slightly shorter 5 - 7 year terms continuing to be popular in Asia and for credit funds.

There has also been an increase in funds with 10+ year terms. The willingness of investors to give managers more time to execute investments is also shown in the extension periods available to managers under fund partnership agreements. Two single year extension periods remain most common but there has been an increase in the number of three single year extension periods.

8 Fund Terms

Managers have also been more creative in agreeing extension provisions to allow themselves even greater flexibility to source and execute the best investments at acceptable prices, with multiple two and even five year extension periods being agreed with investors.

This understanding is also reflected in investment periods having lengthened a little, with 5-7 year investment periods superseding 3-4 years as the most common duration.

As always, industry specific trends remain, with distressed credit funds in particular often having investment periods of three years or below.

FEES

The “two and twenty” model has broadly remained dominant, although with some downward pressure, particularly from the management fee perspective, where the most common management fee is now a little less than 2%.

There is some flexibility around the edges, with some first-time funds charging carried interest as low as 5%, but 20% remains the standard amount.

9 Fund Fees

Managers continue, however, to experiment with preferred return. Technology funds in particular, in light of the “all or nothing” nature of a number of their investments, have sought to lower preferred return expectations, with certain managers receiving carried interest immediately upon investors receiving their money back.

Management fee pressure has been coming to bear for a number of years and this is the first year where fee rates between 1.5% to 2% have outnumbered those in the 2% and above range.

Investors are willing to pay for performance, but are tightening the purse strings on ongoing management fees.

GENERAL PARTNER REMOVAL

Providing investors with the ability to remove the general partner following wrongdoing remains relatively standard, with general partners typically being required to discount any accrued carried interest in the event of a termination for cause scenario.

Managers continue to strongly resist the ability to be removed without cause, conscious of being removed from a portfolio that they have painstakingly crafted for no reason other than investor sentiment. This term is more commonly conceded for start-up funds managed from Asia, although managers will typically negotiate some form of compensation payable on removal, typically determined as a multiple of the annual management fee.

One interesting alternative to no-fault removal is providing investors with the right to wind-up the fund early rather than removing the general partner. This is a powerful tool for investors, while protecting the manager from seeing a competitor pick up and managing a fund portfolio that they have used their expertise to identify and construct. While no-fault removal remains the most common remedy for disgruntled limited partners, the forced winding-up may become more prevalent going forward.

Walkers Fundamentals White Paper 2020 – Private Equity Part 1

Welcome to Walkers’ 2020 Fundamentals White Paper Series, in which we discuss certain trends identifiable among the hedge funds and private equity funds that we helped our clients launch over the last twelve months.

In last year’s White Paper, published in November 2019, managers and their funds appeared to be positioning themselves for market turbulence in the face of global uncertainties and a volatile economic and financial environment. One year on, with the benefit of hindsight, this was something of an understatement. 2020 has tested all aspects of managers’ businesses, from the boardroom to the back office, and in many parts of the world out of the office altogether. All of this, of course, is not to overlook the broader global context of the pandemic and the significant health, economic and political challenges that 2020 has brought and continues to present.

To visit the other parts of the series, please use the direct links below:

Private Equity Trends Part 1

Among the uncertainty and turmoil of 2020, closed-ended fund formation activity has continued at pace, as managers and their advisers have negotiated side letters, launched funds and continued downstream activity, largely operating in a virtual world. In the Cayman Islands, the enactment of the Private Funds Law has seen Cayman closed-ended funds subject to a registration regime for the first time, with existing and newly launched private funds required to provide certain registration information to the Cayman Islands Monetary Authority (“CIMA”). Private funds will also be required to comply with ongoing obligations with respect to operational matters such as audit, safekeeping of assets, valuations and cash monitoring, which obligations largely codify existing best practices familiar to most managers domiciling their funds in the Cayman Islands.

The new regime ensures that the Cayman Islands remains the offshore financial centre of choice for global fund managers launching closed-ended funds, and supports the Cayman Islands’ broader aim of adopting global standards in areas such as anti-money laundering and economic substance.

SPAC ATTACK

The last few months has seen a surge in the formation of special purpose acquisition companies (“SPACs”), also known as ‘blank cheque’ companies, with no commercial operations which go public with the intention of acquiring a target within a set time period (usually 24 months). While SPACs are not new creations, 2020 has seen a record number launched. It has also seen a number of established fund managers tapping the public markets for capital, with Oaktree, Apollo and Cerberus, among others, successfully bringing SPACs to market. SPACs provide another tool in the fund raising armoury of established managers, as well as showing the confidence investors have in their ability to source and execute high quality deals. Private equity managers whose funds are approaching the end of their terms will also be looking carefully at a new tranche of potential buyers who will be racing against the clock to complete a deal.

4 SPAC

SPACs are typically formed as Cayman Islands exempted companies or Delaware corporations, each offering a relatively simple and well-trodden path to market. The various legal issues arising in respect of the establishment of a Cayman Islands exempted company as a SPAC have been considered in detail by those practicing in the field. Factors such as the scope of fiduciary duties of directors of SPACs, issues around corporate opportunity and the availability of a robust merger regime have allowed the Cayman Islands to remain a jurisdiction of choice for fund managers and other sponsors to form and launch their SPACs.

FUND SIZES AND STRUCTURES

Cayman Islands exempted limited partnerships (“ELPs”) remain by far the most common choice of entity for Cayman Islands closed-ended funds, with the few funds structured as exempted companies or limited liability companies coming to market typically to accommodate specific investors. Cayman Islands exempted companies remain the most common general partner vehicle, although ELPs and foreign companies, typically Delaware LLCs, remain popular alternatives. Foreign partnerships, typically Delaware limited partnerships, are also used from time to time.

Cayman Islands exempted companies are particularly popular with Asian start-up managers, being their almost exclusive general partner vehicle of choice and reflecting a desire to keep the entire fund structure located in the Cayman Islands.

Following a spike in sub $500 million fund raises in previous years, this has been a year in which established managers raising successor funds have traded on their track records to raise larger funds, with particular growth in the $500 million to $3 billion range.

5 Target Fund Size

Hard caps on commitments remain unusual, most commonly imposed on managers raising smaller funds by anchor investors keen to prevent dilution.

Small funds have also been the most likely to avoid the requirement for a general partner commitment, with investors understanding of the financial pressures on new managers. Outside of the smaller funds however, investors continue to insist on managers or their affiliates having skin in the game, either on a percentage or absolute number basis. The numbers vary widely by reference to geography, fund size and reputation of the manager, with percentage amounts ranging from 1%-5%, most typically around the 2% mark, and dollar amounts dependent entirely on fund size.

Twelve months remains the most common fundraising period, although certain funds, particularly in the credit sector, often look to raise money more quickly.

FUND STRATEGIES

Cayman continues to see funds encompassing a broad range of strategies. Credit remains extremely active while the uptick in technology/venture funds from prior years remains broadly stable.

There has also been some recovery in the hard asset space, with both real estate and infrastructure funds proving relatively popular supported by particularly strong activity in the logistics/warehousing sectors, tracking the significant growth in online retailing. Impact and socially conscious investing has also remained of interest, with a fund focussing on green agribusiness successfully raising money for the first time.

6 Fund Strategies

The strength of Asian capital saw certain region-specific strategies come to market with China focussed funds continuing to be active, including a fund focussing specifically on Chinese cultural and leisure activities.

The onset of the pandemic saw a slew of dislocation funds come to market, with managers raising capital for funds with extremely broad parameters across investment strategies, including credit, technology and buyouts, established specifically to take advantage of any opportunities thrown up by the dislocation in the markets.

FUND GEOGRAPHIES

Global strategies remain popular, with North America and Asia remaining the most significant target regions for investments for funds limited by geographical region.

7 Fund Regions

Europe focussed Cayman funds remain quiet, with some activity in the more niche geographical markets such as Africa, Australia and Japan.

Walkers Fundamentals White Paper 2020 – Hedge Funds Part 1

Welcome to Walkers’ 2020 Fundamentals White Paper Series, in which we discuss certain trends identifiable among the hedge funds and private equity funds that we helped our clients launch over the last twelve months.

In last year’s White Paper, published in November 2019, managers and their funds appeared to be positioning themselves for market turbulence in the face of global uncertainties and a volatile economic and financial environment. One year on, with the benefit of hindsight, this was something of an understatement. 2020 has tested all aspects of managers’ businesses, from the boardroom to the back office, and in many parts of the world out of the office altogether. All of this, of course, is not to overlook the broader global context of the pandemic and the significant health, economic and political challenges that 2020 has brought and continues to present.

To visit the other parts of the series, please use the direct links below:

Hedge Fund Trends – Part 1

As in prior years, our purpose in this White Paper is to analyse trends we see in the terms of newly-launched funds, and consider them in the broader context. While few could have predicted the cause or scale of 2020’s volatility, a period of greater uncertainty had been widely forecast for several years. This had started to show in fund terms: longer and harder lock-ups, greater use of liquidity management tools like gates and side pockets, as well as a shift in the relative popularity of the key strategies.

A RESURGENCE OF MULTI-STRATEGY FUNDS

Looking first at questions of strategy, equity funds retain both their absolute and relative dominance over other strategies in terms of number of funds launched this year. This is consistent with recent reports from Preqin, which suggest equity funds as a group out- performed all other strategies, benefitting from the equity market rally earlier in the year. Multi-strategy funds were also significantly more popular than in prior years, possibly reflecting a trend towards larger institutionally-managed diverse vehicles (with attendant risk management and, ideally, smoother returns). Preqin also noted that multi-strategy managers have seen smaller outflows than other strategies so far in 2020[1].

1 Hedge Fund Strategies
FOCUS ON FEES

In prior years we have reported the slow but steady decline of the 2% headline management fee, and this year was no different: the median management fee was 1.25%, and less than 10% of funds had a management fee of 2% or more. Funds are often launching with tiered fee structures too (our 1.25% median is based on the highest fee classes in each fund under review), so many investors will be paying less.

For several years we have observed the trend of fewer funds launching with a 20% headline performance fee rate, and the rise of funds subject to an 11-19% rate. 2020 was the first year that funds in the 11-19% category outnumbered the 20% funds. This is consistent with data reported by other industry observers: HFR’s most recent quarterly survey suggested average incentive fees of 17.55%.[2]

2 Performance Fees

REDEMPTION TERMS

Half of funds launched this year used some form of lock-up, more than in any previous year of our survey. Of these funds, nearly 60% have a lock-up period of 18 months or longer, which represents a slight increase over prior years, but too early to call a trend. As in prior years, lock-ups tend to be implemented as ‘hard’ lock-ups (a complete restriction on redemption) rather than soft (redemptions during the lock-up period are possible, subject to an early redemption fee).

The use of gates is significantly higher this year than in prior years, continuing an upward trend we have observed since 2018. This year, over 40% of funds employed some form of gate, and of those funds approximately two-thirds imposed the gate at the level of the investors individually, rather than the fund as a whole.



[1] 2020 Preqin Global Hedge Fund Report

[2] HFR Market Microstructure Report, Q2 2020 (September 2020)

Walkers Fundamentals White Paper 2020 – Hedge Funds Part 2

Welcome to Walkers’ 2020 Fundamentals White Paper Series, in which we discuss certain trends identifiable among the hedge funds and private equity funds that we helped our clients launch over the last twelve months.

In last year’s White Paper, published in November 2019, managers and their funds appeared to be positioning themselves for market turbulence in the face of global uncertainties and a volatile economic and financial environment. One year on, with the benefit of hindsight, this was something of an understatement. 2020 has tested all aspects of managers’ businesses, from the boardroom to the back office, and in many parts of the world out of the office altogether. All of this, of course, is not to overlook the broader global context of the pandemic and the significant health, economic and political challenges that 2020 has brought and continues to present.

To visit the other parts of the series, please use the direct links below:

 

Hedge Fund Trends – Part 2

GOVERNANCE MATTERS

This year showed a sharp reversal of a trend we have been watching for several years. Since 2016, the number of funds launching with independent directors on the board had started a gentle decline. Reasons for this decline were diverse, but included cost sensitivities for start-up managers, and, among the more established institutional managers, internal controls and governance processes that were sufficiently trusted by their investors not to require further independent oversight. While these forces are no doubt still relevant, 2020’s survey saw the highest percentage we have ever recorded of funds appointing at least one independent director (87%). There are several reasons we might consider to explain this return to independent governance, supported by some of the trends we have already observed above. This appears, at least in part, to be a direct response to the demand from institutional investors. Additionally, as the management of cross border issues and multiple regulatory regimes become ever more complex, our institutional clients want to ensure they have on-market, best in class service providers across the board.

3 Board Comp

Certain of the strategies that have dominated this year often have a substantial governance component to them – part of the ‘pitch’ of a multi-strategy fund, for example, is that the manager has the strong governance tools to be able to manage multiple underlying strategies and trading teams. As we have seen, more funds than ever are incorporating terms such as lock-ups and gates that are designed, primarily, to help funds manage challenging liquidity issues – if managers are anticipating these issues and reacting in their fund terms, it might be expected that investors are doing likewise and reacting by requiring enhanced oversight.

The selection of an appropriate board continues to be a critical process on which managers should focus, and guiding managers through these processes remains a key part of our role as Cayman counsel.

FUND TERMS IN ACTION: NAVIGATING STRESSED SITUATIONS

Beyond fund launches, this year’s industry commentary has noted several high profile and long-established funds commencing their wind-down, or electing to turn into family offices to manage the principals’ capital. In addition, market forces and investors’ own allocation decisions have seen many funds dealing with redemptions from their largest investors, or otherwise restructuring to position for market turbulence or in response to the pandemic or other global developments.

Funds with clear, flexible documentation have more options in addressing unforeseen stresses. Managers that maintain a close and open relationship with their investor base and service providers can propose and successfully adopt restructurings or other solutions that may not be directly contemplated by the fund’s documents.

LOOKING AHEAD TO 2021

For all of the disruption and challenges that 2020 has posed, these are also times of opportunity. Hedge fund managers have struggled for many years with the broadly rising markets and central bank support limiting the sorts of dislocations they can trade. While government stimulus and market support has likewise been an element of the response to 2020’s challenges, the markets have nonetheless been more volatile than in prior years, offering the perfect environment for many hedge funds. Managers with all-weather strategies are in it for the long term and will therefore be less affected by the shape, size and speed of recovery. An increasingly vocal investor base on matters of governance, diversity, ESG factors and so on, is requiring managers to re-assess not just the delivery of returns, but how those returns are delivered.

In addition, 2020 has provided the industry with an opportunity to test some of the assumptions about the way we work. Capital raising in a working from home environment requires a different skillset, but might reduce the travel time and costs that would otherwise be required of principals. Fortunately, most of our clients are well set up to manage their business, operations and trading from remote locations and have not skipped a beat. However, like many in the industry they are feeling the second order effects of WFH for an extended period, and worry about the potential threat to their business culture.

These trends will take some time to reveal them- selves, and we look forward to returning to these questions next year to see how managers respond.

The Legal 500 Country Comparative Guides 2020 - Cayman Islands: International Arbitration

In the 2020 issue of the Legal 500 Country Comparative Guide - Cayman Islands: International Arbitration, Nick Dunne, Andrew Gibson and John Crook of the Walkers Insolvency & Dispute Resolution team provide an overview of international arbitration laws and regulations applicable in the Cayman Islands. 

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