Hedge funds increasing offering clients co-investment opportunities through SPVs

01 Jun, 2015

An increasing number of hedge fund managers are offering investors co-investment opportunities through special purpose vehicles (SPVs) as the convergence between hedge funds and private equity continues to grow.

These SPVs will typically offer clients the opportunity to gain exposure to private or public investments that may fall outside of the flagship fund vehicle’s investment parameters or investment criteria. These SPVs, which will usually have exposure to illiquid assets, will give investors a carried interest waterfall, something commonly seen in private equity.

“The line is getting increasingly blurred between the two asset classes with some private equity managers launching hedge funds and vice versa. These SPVs that are being set up by hedge funds are often bespoke and give clients the opportunity to co-invest in illiquid assets that might be beyond the remit of the fund manager’s investment guidelines,” said Steven Nadel, partner at Seward & Kissel in New York.

Oftentimes, investors in these SPVs are offered fee discounts from the typical two per-cent management fee and 20 per-cent performance fee levied by hedge fund managers. “Many managers will provide investors with a fee discount for locking into the SPV for a period of time,” commented Nadel.

This is evident in Seward & Kissel’s 2014 hedge fund survey published in February 2015, which found 72 per-cent of managers offered lower management fee rates to investors who agreed to a lock-up that was longer than one year. This is significant jump from 2013 when 62 per-cent of managers offered fee discounts in exchange for one or more year lock-ups.

Some have warned  that hedge funds dabbling in private equity risk suffering a liquidity mismatch. A typical private equity structure will usually employ a 10 year lock in for investors whereas hedge funds investing into illiquid private companies appear to be offering lock-ups for no more than one or two years at a stretch.

A report by the prime brokerage arm of J.P. Morgan in March 2013 acknowledged there had been a surge in hybrid fund structures with characteristics of both private equity and hedge funds. This has been buoyed by growing investment opportunities in less liquid distressed assets. 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. These assets are proving to be an attractive investment proposition for some fund managers.



J.P. MorganBasel IIISeward & Kissel