The Hedge Fund Law Report

The definitive source of actionable intelligence on hedge fund law and regulation

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By Topic: High Water Marks

  • From Vol. 9 No.37 (Sep. 22, 2016)

    AIMA Survey Identifies Key Ways That Managers Align With Investors, Including Alternative Fee Structures, Skin in the Game and Customized Investment Solutions

    The Alternative Investment Management Association (AIMA) recently released a paper reviewing the nature of relationships between hedge fund managers and their investors. AIMA’s report explores a number of methods that managers are using to strengthen their relationships with investors, including by employing alternative fee structures, investing significant capital in their funds and offering customized investment solutions. This article examines these and other key takeaways from the report. For additional insight from AIMA, see “Basel III Raises Prime Brokerage Costs for Hedge Fund Managers” (Feb. 18, 2016); “Structures and Characteristics of Activist Alternative Investment Funds” (Mar. 12, 2015); and “Key Drivers of the Bifurcation of the Hedge Fund Industry Between Larger and Smaller Managers” (May 24, 2012).

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  • From Vol. 9 No.28 (Jul. 14, 2016)

    Dechert Panel Discusses Recent Hedge Fund Fee and Liquidity Terms, the Growth of Direct Lending and Demands of Institutional Investors 

    A recent program sponsored by Dechert offered an overview of the current hedge fund landscape, focusing on fee and liquidity terms, the growth of direct lending, prime brokerage and institutional investors’ perspectives on alternative investments. The program featured John D’Agostino, a managing director at DMS Offshore Investment Services Ltd., and Dechert partners Matthew K. Kerfoot, David A. Vaughan, Karl J. Paulson Egbert and Timothy Spangler. This article highlights the panelists’ primary insights. For further insight from Kerfoot, see “Dechert Webinar Highlights Key Deal Points and Tactics in Negotiations Between Hedge Fund Managers and Futures Commission Merchants Regarding Cleared Derivative Agreements” (Apr. 18, 2013). For additional commentary from Vaughan, see “A Practical Comparison of Reporting Under AIFMD Versus Form PF” (Oct. 30, 2014). For further remarks from Egbert, see “Capital-Raising Opportunities, Regulatory Hurdles and Cultural Challenges Faced by Hedge Fund Managers in China and the Middle East” (Jun. 23, 2016).

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  • From Vol. 8 No.23 (Jun. 11, 2015)

    Modified High Water Mark Provisions May Be Difficult for Managers to Market and Implement (Part Two of Two)

    Hedge fund managers unable to subsist entirely on management fees may risk losing key investment personnel without receiving (and therefore being able to offer key people part of) any incentive compensation.  Traditional high water mark provisions – which prevent hedge fund managers from receiving any incentive or performance fees until prior losses are recouped – can result in managers going years without performance compensation, even after they have begun to turn the fund’s performance around.  To alleviate this pressure, some managers may consider using modified high water mark provisions, allowing them to receive lower amounts of incentive compensation during periods when the fund remains below its high water mark.  However, such provisions are not common in the hedge fund industry and may impact the marketability of the manager’s fund, especially as investors continue to place increasing pressure on hedge fund fees.  See “Deutsche Bank Alternative Investment Survey Explores Fees and Liquidity Trends, the Landscape for Investment Intermediaries and Early Stage Investment Terms (Part Two of Two),” The Hedge Fund Law Report, Vol. 8, No. 22 (Jun. 4, 2015).  This second article in a two-part series discusses the industry prevalence of and investor reception to modified high water marks and examines issues that hedge fund managers should consider before implementing a modified high water mark.  The first article analyzed elements of modified high water mark provisions and explored the benefits of such provisions.

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  • From Vol. 8 No.22 (Jun. 4, 2015)

    Modified High Water Mark Provisions May Reduce Risk and Enable Hedge Fund Managers to Retain Talent (Part One of Two)

    Following a market downturn or period of bad performance, traditional high water mark provisions – which prevent hedge fund managers from receiving incentive or performance fees until prior losses are recouped – can result in additional pressure on hedge fund managers, even after those managers have begun to turn fund performance around.  Managers may not be able to subsist entirely on management fees and may risk losing key investment personnel without incentive compensation.  To alleviate some of this financial pressure, certain managers may consider using modified high water mark provisions, allowing them to receive lower amounts of incentive compensation during periods when the fund remains below the high water mark.  Seward & Kissel’s 2014 New Hedge Fund Study noted that all of the funds analyzed included some type of high water mark, and 7.4% of funds in the study included a modified high water mark.  See “Seward & Kissel New Hedge Fund Study Identifies Trends in Investment Strategies, Fees, Liquidity Terms, Fund Structures and Strategic Capital Arrangements,” The Hedge Fund Law Report, Vol. 8, No. 9 (Mar 5, 2015).  This article, the first in a two-part series, analyzes elements of modified high water mark provisions and explores the benefits of such modified high water marks.  The second article will discuss the industry prevalence of and investor reception to modified high water marks and examine issues that hedge fund managers should consider before implementing a modified high water mark.

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  • From Vol. 4 No.3 (Jan. 21, 2011)

    2010 Greenwich Associates Global Custodian Prime Brokerage Study Discusses Counterparty Risk Concerns, Sources of Assets, Balance Spreading, Leverage Levels, Separately Managed Accounts and Hedge Fund Staffing Benchmarks

    In the 2010 Greenwich Associates Global Custodian Prime Brokerage Study, institutional financial services consulting and research firm Greenwich Associates offered insight on the relationship between hedge funds and prime brokers, high water marks, counterparty risk concerns among hedge fund managers, hedge fund money raising, spreading of hedge fund cash and non-cash balances, use by hedge funds of leverage and separately managed accounts and hedge fund manager staffing.  The insights in the study were based on interviews with over 1,800 hedge fund managers across North America, Europe and Asia-Pacific.  This article summarizes the key findings of the study.

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  • From Vol. 2 No.43 (Oct. 29, 2009)

    What Happens to High Water Marks When Managers Restructure Hedge Funds?

    In July 2009, in response to requests for $4.7 billion in redemptions in Cerberus Partners, L.P. and Cerberus International, Ltd., hedge and private equity fund manager Cerberus Capital Management, L.P. established a restructuring plan.  The plan offered investors the opportunity to move their assets into one of two new funds: Cerberus Partners II LP and Cerberus International II Ltd.  Both are expected to have lower fees than the older funds, but a longer, three-year lock-up.  Cerberus also indicated that it would create special purpose vehicles (SPVs) for investors in each of the older funds who do not elect to participate in the new funds; interests in the SPVs are not expected to be transferable.  Cerberus expects to charge investors who stay in the SPV a 0.5 percent annual management fee, and it has not yet announced a specific timeline for the liquidation of the SPVs.  Rather, Cerberus has indicated that it intends to sell the assets in the SPVs as expeditiously as practicable and that it will distribute liquidation proceeds when such proceeds become available.  This article focuses on a provision of the Cerberus restructuring plan that would allow investors in the old funds to carry their high water marks (HWMs) over into the new funds.  Specifically, for two years after the HWM is reached, Cerberus plans to waive 60 percent of its usual performance fee.  Cerberus has not stated what the “usual performance fee” is, except to indicate that it is less than the typical – or formerly typical – 20 percent.  More generally, in light of a significant volume of fund restructurings currently occurring and anticipated in the coming months, this article examines the rationale for and incentive effects of HWMs; the barriers preventing managers below high water marks from simply closing up shop and reopening in a different corporate form and potentially under a different brand; how managers under HWMs have been renegotiating performance fees; and the clout of institutional investors in negotiations with respect to carrying over old HWMs to new or restructured funds.

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  • From Vol. 2 No.33 (Aug. 19, 2009)

    How Are Hedge Fund Managers with Funds Under their High Water Marks Renegotiating Performance Fees or Allocations?

    Despite solid year-to-date performance, many hedge funds remain below their prior net asset values (NAVs), in many cases achieved during the first half of 2007.  As a technical matter, the governing documents of most hedge funds contain so-called high water mark or loss carry-forward provisions stating that the manager cannot collect a performance fee or allocation until the NAV of the fund exceeds its highest prior level.  But as a practical matter, the performance fee is a critical part of the hedge fund business model.  Among other things, performance fees enable managers to offer the compensation packages required to attract and retain top investment and other talent; and such talent is necessary to offer the incremental advantages in terms of insight and analysis that distinguish one hedge fund from another – that enable one fund to yield alpha while others just deliver beta or losses.  And hedge fund investors recognize this: by and large, they are invested in hedge funds for uncorrelated, absolute returns.  They’re not in hedge funds – at least primarily – to save money on fees.  (Fee saving is what bond and stock index funds are for.)  Investors want their managers incentivized, and thus investors have generally been willing to negotiate alternative arrangements with respect to performance fees or allocations with managers whose funds are below their high water marks.  In a sense, the experience of the past year and a half has demonstrated that high water mark provisions in hedge fund documents do not provide a roadmap for how the relationship between hedge fund managers and investors actually operates.  Rather, such provisions provide a starting position for negotiations between hedge fund managers and investors with respect to performance fees or allocations so long as a manager’s best days remain, at least for the moment, behind him or her.  This article explores what performance fees and allocations are (including a discussion of the tax purpose and effect of mini-master funds); how high water mark provisions affect a manager’s ability to collect such compensation; specific ways in which managers and investors are renegotiating performance fees or allocations in the “shadow” of high water mark provisions; the rationale among managers for seeking, and among investors for consenting to, such revised performance fee or allocation arrangements; and the process for obtaining consent to such revised arrangements, and the circumstances in which negative consent may be viable.

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  • From Vol. 1 No.22 (Oct. 10, 2008)

    High Water Marks Take Center Stage in a Year of Weak Hedge Fund Performance

    In what increasingly looks like the worst year for the hedge fund industry in nearly two decades, some investors are wondering if this could be a good time to bargain for better investment terms. Faced with a wave of redemption requests, funds have taken various approaches to retaining investors. One increasingly common approach is reducing fees in exchange for a longer lock-up. Another approach, slightly less common, involves requests from new investors (or from current investors contemplating new investments) to come in under the terms of an old high water mark. Such arrangements can delay, sometimes substantially, the date on which a hedge fund manager laboring under a high water mark will next earn its performance fee.

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