the current hedge fund landscape: lp and gp …€¦ · the current hedge fund landscape: lp and gp...

THE CURRENT HEDGE FUND LANDSCAPE: LP AND GP PERSPECTIVES NAPPA 2016 LEGAL EDUCATION CONFERENCE Moderator:

Maureen M. Hazen, General Counsel, State Board of Administration of Florida

Presenters:

James Keith (JK) Brown, Executive Managing Director, Head of Investor Relations, Och-Ziff Capital Management Charles Nightingale, Head of Legal & Investment Structuring, PAAMCO Jedd Wider, Partner, Morgan, Lewis & Bockius LLP

June 21-24, 2016

New Orleans, Louisiana

Index

• Discussion Outline – Pages 3-6

• Current Investment Terms, Conditions and Issues – Pages 7-30

• State Board of Administration of Florida Hedge Fund Investment Policy – Page 31

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DISCUSSION OUTLINE

Discussion Outline

• Fees – Management Fees – Incentive Allocations

• Liquidity – Accelerated Withdrawal Rights – Frequency of Withdrawals – Withdrawal Gates & Suspensions

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Discussion Outline (cont’d.)

•Transparency – Reporting Items

– Notice Requirements – Extensive

– MFN Trends

– Confidentiality Issues and Public Records/FOIA Laws

•Operational – What are the expectations of institutional investors with respect to the

operations of managers? Any difference when it comes to start-up managers?

– How do investors expect managers to overcome the increasing barriers to entry, in particular with regards to operations and compliance?

– Selection and role of service provides; in-sourcing v. out-sourcing (e.g., CCO role)

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Discussion Outline (cont’d.)

•Special Topics/Areas of Interest – Customized Hedge Fund Products

– Funds of one

– Managed Accounts

– GP Views on SEC Regulatory Trends

– LP Views on SEC Regulatory Trends; in particular, how has the SEC’s focus on hedge funds impact due diligence by institutional investors?

– Unique issues funding start-up managers: Due diligence, founders classes, seeding and anchor investors

– Views on Public Perception of Hedge Funds

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CURRENT INVESTMENT TERMS, CONDITIONS AND ISSUES

Fees

• Standard Terms

– Management Fees

Monthly or quarterly in advance, typically at an annual rate of between 1%-2%

Management fee rate ladders sometimes tied to differing withdrawal rights

– Incentive Allocations/Fees

Annual 15%-20% on net profits (sometimes over a hurdle), subject to a loss carry-forward

Incentive allocation/fee rate ladders sometimes tied to differing withdrawal rights

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Fees (cont’d.)

• Market Developments

– Management Fees

Investor push for discounts or ladders based on size of subscription (or commitment) or size of overall investment with Manager and its affiliates

– Incentive Allocations/Fees

Increase in commingled funds with no incentive compensation

Greater investor interest in bespoke products with no performance compensation or alternative performance compensation arrangements (e.g., multiyear performance periods or partial payment)

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MFN

• MFN → Investor Ask

– Existing Side Letters

Representation by GP/manager that no other side letters exist other than those previously disclosed

– Future Side Letters

Notice and copies of all future side letters

Applies to all preferential terms

Automatic unless investor notifies within 30 days

No tiering (preferably). If tiering, applies to aggregate investment by investor and affiliates in fund and all parallel funds and accounts

10

Reporting and Other Disclosure

• Reporting

– Standard Terms

Monthly performance estimates

Monthly capital statements

Quarterly performance reports

Annual audited financial statements

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Reporting and Other Disclosure (cont’d.)

• Reporting (cont’d.)

– Market Developments

Weekly performance estimates

Monthly portfolio summaries, including:

gross long positions, gross short positions, and net positions by strategy, security type, geographic region, and sector

top five long positions and top five short positions

performance attribution

leverage levels

Monthly portfolio holdings reports on a real-time or lagged basis

Monthly risk reports provided through a risk aggregator

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• Market Developments (cont’d.)

Monthly statements of management fees and performance compensation

Monthly or quarterly valuation reports, including ASC 820 classification (highlight on Level 3 assets)

Annual reconciliations of audit versus capital account statements

Annual conflict of interest reports

Annual compliance certificates

Annual Fund-level tax reporting

ERISA Section 408(b)(2) service provider disclosure

Form PF

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• Notice Requirements

– Standard Terms

Material amendments of Fund documents

Certain amendments to Form ADV, as required under applicable securities laws and regulations

Key person events (not majority)

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• Notice Requirements (cont’d.)

– Market Developments

Bad acts involving GP, Manager, or Investment Personnel

Breaches of standard of care/fiduciary duty

Breaches of Fund documents or side letters

Non-routine investigations or findings of violations of securities laws or regulations

Convictions, pleas of nolo contendere or guilty pleas to felonies or crimes involving fraud

Violations of other applicable laws, regulations, or investor policies, including ERISA (or comparable state law) or investor-specific investment restrictions

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Key person events (expanded application)

Other events impacting GP/Manager

Changes in ownership or control

Changes in investment and operations personnel

Bankruptcy or insolvency

Material adverse change to business, operations, or conditions

Legal claims

Any amendment to Form ADV

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Events impacting Fund

Changes in corporate structure

Changes in overall investment objective or strategy

Amendments to Fund documents, including valuation procedures

Changes in Fund administrator, prime broker/custodian, or auditor

Fund assets become “plan assets” under ERISA

Failure to value Fund assets in accordance with valuation procedures

Material decline in Fund’s net asset value

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Events impacting Fund (cont’d.)

Investments in “side pocket” or other illiquid investments

Use of soft dollars outside the Section 28(e) safe harbor

Indemnifications claims

Indemnification advances/expense reimbursements

Legal claims or governmental proceedings

IRS audit

Imposition of a withdrawal gate

Suspensions of determination of Fund net asset value

Suspensions of withdrawal rights or payments of withdrawals proceeds

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Events impacting investor

Acts or omissions by GP, Manager or investment personnel causing investor to receive materially adverse publicity

Acts or omissions by GP, Manager, or investment personnel otherwise materially adversely affecting investor’s reputation

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Accelerated Withdrawal Rights

• Breaches → Investor Ask

– Prompt Notice

Breach of the fund documents

Breach of the fund’s standard of care

– Immediate withdrawal right, without any gate, lock-up, holdback, suspension, fee or other penalty

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Accelerated Withdrawal Rights (cont’d.)

• Regulatory and Legal Claims → Investor Ask

– Prompt notice

Non-routine investigation of securities law violation

Finding of securities law violation

Conviction, plea nolo contendere or guilty plea to a felony or a crime involving fraud

Violation of ERISA

IRS audit of the fund


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• Changes to the Fund → Investor Ask

– Prompt Notice

Change to the fund’s investment objective or strategy

Change to the fund’s corporate structure

Amendment to the fund documents

Amendment of the fund’s valuation procedures

Use of “soft dollars” outside the Section 28(e) safe harbor


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• Changes to Service Providers → Investor Ask

– Prompt notice

Change in ownership or control of GP or manager

Bankruptcy, liquidation or insolvency of GP or manager

Material adverse change to business of GP or manager

Change in the fund’s administrator, prime broker, custodian, auditor or legal counsel


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• Amendment of Fund Documents → Investor Ask

– Right to withdraw prior to effective date of amendment if investor does not consent to any amendment requiring investor consent

– Withdrawal not subject to applicable notice requirements, gate, lock-up, holdback, suspension, fee or other penalty

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• Withdrawals by Insiders → Investor Ask

– Notice of intended withdrawal by the GP/manager, any key person or any affiliate of 25% or more over a rolling 12 month period, excluding withdrawals of performance compensation or for tax purposes

– Right of investor to withdraw at same time of (or prior to) insider’s withdrawal date


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• Violations of Investor’s Applicable Law, Regulation or Policy → Investor Ask

– Immediate withdrawal right if investment would violate:

Securities laws or regulations

ERISA or comparable state law

Investor-specific statutes, regulations or policies, including placement agent policies


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Payment of Withdrawal Proceeds

• Withdrawal Gate → Investor Ask

– The withdrawal gate will not apply for more than 12 consecutive months after the initial withdrawal date

– The withdrawal gate will apply equally to all investors making a withdrawal on the same withdrawal date

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Payment of Withdrawal Proceeds (cont’d.)

• Distributions in Kind → Investor Ask

– 3 days’ prior notice of intended distribution in kind

– Right of investor to not accept distribution in kind, in which case the GP/manager agrees to use best effort to liquidate the fund assets

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OPERATIONAL DUE DILIGENCE AREAS OF FOCUS

Core Information Technology and Business Continuity Planning

Counterparties, Cash, Margin and Collateral Risk Management

Structural, Taxation and Corporate Governance Considerations

Pricing and Valuation

Accounting and Risk Reporting Oversight

Business Support, Systems and Infrastructure

AREAS OF FOCUS

Trade Origination, Record and Settlement

Compliance and Regulatory

Reputable and Appropriate 3rd Party Providers

Cash Controls and Safeguardi ng of Client Assets

cornpleteAlpha For illustrative purposes only. PAAMCO may use some or all of the techniques described in this document.

See applicable endnote.

PAAMCO

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OPERATIONAL DUE DILIGENCE IMPERATIVES

A willingness to be subject to a full Operational Due Diligence review and to provide the

requisite transparency

Corporate governance and legal framework such that the interests of investors are

appropriately safeguarded

Adequate segregation between investment activities and control functions. Critical to

this is the existence of an experienced individual (typically a CFO or COO) who

manages operational risk and is responsible for independent risk oversight

A written pricing policy that details appropriate methodologies and independence in the

valuation process

Counterparty terms that are appropriate to the strategy of the fund

Competent and independent external administrator and auditor

An adequate program of compliance that should meet regulatory requirements and

provide a framework for reasonably safeguarding investor interests

Adequate controls that support the safeguarding and management of fund assets

A dual signatory policy for the control of cash and asset transfers

A generally stable operating environment with appropriate safeguards and controls to

support security of data and infrastructure, with policies and procedures covering

backup and disaster recovery

For illustrative purposes only. PAAMCO may use some or all of the techniques described in this document.

See applicable endnote.

PAAMCO

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STATE BOARD OF ADMINISTRATION OF FLORIDA HEDGE FUND INVESTMENT POLICY