An increasing number of new hedge fund managers are debuting with an incentive allocation hurdle, which guarantees investors a baseline return before the manager earns a performance fee, according to the 2023 edition of the Seward & Kissel New Manager Hedge Fund Study.

The proportion of new funds offering such hurdles increased to 40% in 2023 from 15% in 2022. According to Seward and Kissel, this shift reflects investor demand for substantial returns at a time when a risk-free interest rate remains an appealing choice, even if they are increasingly being asked to accept lower liquidity in exchange – a pattern first identified in the study’s 2022 edition.

In 2023, 78% of equity funds and 71% of non-equity funds used lock-ups, which prevent investors from withdrawing capital for a set period of time, or investor-level gates, which limit the amount an investor can redeem at any given time, up from 69% and 67%, respectively, in 2022.

In addition to gaining more breathing room through liquidity constraints, fewer than half of new managers in 2023 avoided offering lower management fees or incentive allocation rates through their founders classes. Only 49% of equity funds (down from 59% in 2022) and 47% of non-equity funds (down from 53% in 2022) provided such incentives, indicating that investors are ready to exchange management fees for the assurance of a hurdle.

The study also found that the minimum initial investment requirement for equity funds has increased significantly, with an average of $2 million in 2023, up from $1.35 million in 2022. In contrast, the minimum initial investment for non-equity strategies has been reduced to $1.5 million from $2.5 million.

Meanwhile, family office participation in hedge fund seeding deals increased in 2023, adding to these investors’ re-entry into the seeding arena following the pandemic. However, institutional investors continued to account for most of the seed investments, with ticket sizes frequently topping $75 million, indicating a trend of increasing check sizes.

“2023 was a year for performance. With investors less inclined to take risk in a high interest rate environment, we saw new managers turn to incentive allocation hurdles to give investors the security they demanded,” said Noelle Indelicato, Seward & Kissel investment management group partner and lead author of the study.

Seward & Kissel LLP, a NY-based law firm focused on hedge fund and investment management, was founded in 1890, and established the first hedge fund ever, A.W. Jones, in 1949.