Views from Capital Intelligence… Looking Ahead

Industry Insights:

Our newsletter, Jack-of-all-Reads, shares the latest and greatest insights in a brief read on a monthly basis. Please let us know of any comments or questions – we welcome and appreciate your continued partnership. Happy Holidays to all and we look forward to continuing our partnership in the new year.

Industry Insights:

1. This month we collected insights from across our team on the industry outlook for next year. We look forward to discussing further with you in January.
   • Outlook for hedge fund launches in 2024. The team is optimistic that we will see both established managers launching new products as well as an increase in specialist strategies which offer unique return streams, different factor exposures, or a combination of the two.
   • Fundraising Environment. While multi-strategy and multimanager funds have been the primary group in the spotlight this year, questions remain around if demand will continue as LPs are more cognizant of fees. We expect to see:
     • A continued interest and demand for uncorrelated, low beta, low net market neutral strategies with a focus on alpha generation.
     • Increased appetite for healthcare and TMT strategies as rates start to decrease and indices hit rock bottom.
     • More interest in tech as LPs have rotated out of the sector and are now underexposed.
     • Interest for event driven strategies may increase as M&A activity rises.
     • While we do see managers launching new products or a 2nd or 3rd vintage of an existing strategy, we are hearing feedback that some investors, particularly endowments and foundations, don’t have the liquidity to invest in the next iteration of a product given existing commitments to other drawdown/capital call types of investments they have made.
     • As we are continue to see managers launching new products, managers need to be mindful around continuing to spend enough time on the flagship funds.
   • Terms and Fees Outlook. Founders share classes have been becoming more illiquid. Nearly all groups have a lock and gate. See below for findings from a recent analysis our team conducted on the evolution of terms for newer managers; we always find it interesting to study the new launch environment as many of these managers set the stage for the innovation of terms for established managers launching new products.
     • Management Fees. In 2023, the average founders share class management fee rose to 1.35%, up from 1.25% in 2022, which marks a return to 2021 levels when the average founders class management fee charged was 1.35%. Interestingly, in 2023, main share class management fees increased 40 bps from their 2021 levels (charging 1.60%), continuing their trend upward.
     • Incentive Fees. The average inventive fees for founders share classes declined over 15% in 2023, down 230 bps from their 2021 levels. Conversely, the average incentive fee for main share classes rose to nearly 19.50%, up from 2022 when the average fee was 18.80% and in line with 2021 when the average fee was 19.50%
     • Liquidity and Lock Ups. 87% of new launches imposed a lock-up in the founders share class, 2/3 of which were soft lock ups. The most common liquidity offered continues to be quarterly with a redemption notice of 60 days.
   • Biggest Challenges to Launching in 2024. Heading into 2024, many firms are navigating the costs of keeping up with legal and compliance requirements given increased SEC activity, as well as grappling with how to attract and retain top talent.
     • Multi-Manager Platforms. Will continue to actively hire and create competition for talent amongst emerging and established managers.
     • Importance of Backing and Seed Capital. The barrier of entry to launching a fund is much higher now – from it being more expensive to run/operate a fund in this inflationary environment to there being less day one capital providers who are able to invest. Additionally, many provide deeper support and partnership that enable managers to scale.
2. Thoughts from ODD. This year has been increasingly important from the operational due diligence perspective. The geopolitical environment and banking crises have prompted many to reevaluate how they view risks.
   • The Latest on the ODD Landscapes. Questions from some ODD groups are becoming more complicated. Previously, managers seemed to have less of a grasp on what they needed to do, that information is now more readily available.
     • AI in ODD: The Wave Of The Future. As managers are exploring different ways that they can leverage AI, ODD professionals are getting quickly educated on how to better understand and diligence it.
     • Counterparty Risk. Diversification and vendor due diligence has been top of mind throughout our conversations with the community. The banking crises this year prompted a resurgence of putting processes in place to combat these risks however, most funds still only have one management company bank account in place.
     • ODD Exam Format: Remains Hybrid.  In a post-COVID world, the industry has been able to strike a balance of creating efficiencies through completing some components of ODD virtually and leveraging tools such as data rooms. The important exercise of visiting managers and participating in face to face meetings continues.
   • Regulatory Changes. The SEC recently came out with their 2024 exam priorities which includes focus the new marketing rule, fiduciary duty rule,, and off channel communications. The SEC is currently aggressive in rule making and enforcement actions. There are new, existing, and upcoming disclosures, which groups will quickly need to adopt.
     • Top of Mind in 2024: Private Fund Rule. This rule has been highly scrutinized as the advisor may no longer able to provide side letters or negotiations. It has brought on more comment letters than any period of time.
     • Spotlight on Preferential Treatment. This will grant information and redemption rights as well as prohibit advisors from offering preferential redemption terms unless offered to all current or future investors. Potential solutions include creating customized reports sent via email or portal, or hosting regularly scheduled calls open to investors.

Please reach out to your Jefferies contact for more information on any of the topics above.

Spotlight on Content and Events:

Jefferies Launch 2025: Many of the trends we highlighted in last year’s Annual State of Our Union remained top of mind through 2023. Decision makers were revisiting their assumptions, and redefining their organizations in efforts to sustain themselves through challenging periods, or fuel growth amidst dislocation. Stay tuned for the Jefferies Launch 2025 series which will be released with both written and video components. In this series, we leverage expert views on what potential founders need to know now before launch including costs, the challenges, and potential upsides.

Interesting Service Provider Reads: Highlighting Topical Content from Industry Leaders

Lowenstein Sandler – The SEC’s Private Fund Adviser Rules Explained — Part 4: The Quarterly Statement Rule

Vigilant Compliance – 8 Important Considerations for Dual-Hatted CCOs

Waystone Compliance – SEC 2024 Exam Priorities for Private Fund Advisers

Jefferies Prime Services Contacts:

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