Walkers, the Cayman-based law fir specialising in hedge funds, says the popularity of hedge funds among pension funds and other institutional investors has accelerated the trend toward the use of special arrangements, such as side letters, for select fund contributors.
“An increasing number of U.S. pension funds are allocating additional capital to hedge funds,” said Mark Lewis, a partner at Walkers and joint head of the firm’s investment funds team. “The parallel development is the increased demand for more favourable investment terms, often by the use of side letters.”
A side letter is used to change the terms of a hedge fund offering. It is usually drawn up to accommodate the wishes of large institutional investors who want more immediate access to funds or to pay a lower management or performance fee.
“A side letter may also be needed to allow a pension fund to invest in a hedge fund without violating the terms of the pension fund’s charter documents or the provisions of ERISA,” added Lewis. “Driving this trend is a significant increase in the funds allocated to the alternative investment sector, even though institutional investors have lost some of the influence and buying power that they had a few years ago. As hedge funds become a more accepted component of the investment strategies employed by the pension funds and institutional investors, we expect to see more capital allocated by pension funds and traditional institutional investors to hedge funds. The unique investment requirements that these types of organizations have and the amount of capital invested by them will continue to drive the need for side letters.”
In the year ended 31 December 2004, Cayman enjoyed a 112% increase in the number of hedge funds registered there. The attractions include no tax, the Cayman Islands Stock Exchange, and the local offices of all major banks and accounting firms.