GAIM Ops Cayman: Hedge funds increasingly launching hybrid PE vehicles

08 Apr, 2014

A growing number of hedge fund managers are launching hybrid vehicles more akin to private equity, according to panellists speaking at GAIM Ops Cayman.

“Hedge fund managers are doing a lot of different things and one trend I have noticed is the growth in managers adopting private equity type strategies and putting these into separate vehicles,” said Joseph Mause, chief financial officer at Standard General.

A report by J.P. Morgan’s prime brokerage business in March 2013 highlighted the main catalyst for the growth in hybrid fund structures was the growing investment opportunities in less liquid distressed debt assets. 

A study in February 2014 by New York-based law firm Seward & Kissel found newly launched US hedge funds were imposing tougher redemption terms on investors. Eighty-nine per-cent of new funds restricted redemptions to a quarterly or longer-term basis in 2013 compared with 64% in 2012, added the Seward & Kissel report. The number of funds employing a hard lock up, usually of one year, rose dramatically from 8% in 2012 to 27% in 2013, it continued, indicating a growing convergence between hedge funds and private equity.

Basel III and various national regulations are forcing banks to deleverage and restructure their balance sheets by devolving themselves of illiquid, non-core assets such as collateralised loan obligations and residential mortgage backed securities.  Managers scooping up these high-yield illiquid securities are also generating quality returns. Nonetheless, investor interest has remained static, said the J.P. Morgan study.

“We are seeing an uptick in hybrid vehicles. Prior to the financial crisis, a number of managers launched liquid vehicles but relied on side pockets and gates when the crisis unfolded. These hybrid structures allow managers to look at less liquid products and give investors realistic liquidity terms rather than just arbitrary gates and side-pockets. We are going to see a proliferation of hybrid vehicles in the alternatives industry,” commented one due diligence professional at a major fund management house, speaking under Chatham House Rules.

J.P. Morgan’s report highlighted these hybrid vehicles afford investors access to both liquid and illiquid securities within the confines of a single fund without the constraints of a private equity vehicle.

However, the illiquid nature of the underlying investments in these hybrid structures does cause trepidation among some allocators and the J.P. Morgan study said investors were not rushing into these vehicles. The same study added that hybrid vehicles were attracting capital from funds of hedge funds, family offices, foundations and endowments. While pension funds have expressed a slight interest in these products, many prefer to invest in hybrid funds through single-LP vehicles or funds of one. 

GAIM Ops Caymanprivate equityJ.P. Morgan