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.