Jul

31

Hedge Fund Sidebar Letters

July 31, 2004 | Leave a Comment

Sidebar letters are special deals cut for certain investors that allow them favorable terms over other investors. These sidebar letters can really hurt your investment severely. Typical sidebar letters simply ask for slightly favorbable liquidity, some receive reduced incentive and management fees and others include some sort of charitable agreement.

How can this hurt you?

Well, the liquidity sidebar can. I have heard of sidebar letters for a certain very well known hedge fund manager where he requires a only a few days notice to a manager to ask for a redemption. The event is usually triggered by a drawdown % over a certain time period. If this investor liquidates, funds are needed immediately to satify the redemption and obviously this will hurt your investment because of what is called “redemption risk”. The ability to liquidate the portfolio without hurting other investors. If the portfolio is higly illiquid or partly illiquid there are going to be severe problems.     

I do not necessarily have any issues with sidebar letters for management and incentive fees. If a manager wants to reduce their fees, that is their business. But from another perspective, you may be conducting your own due diligence and making assumptions on how much the manager is taking in on fees, when the amount might be significantly lower. This could affect hiring, operations, overhead, etc.   

Other sidebars run can be just some deal where the manager will charge the investor the standard 20% incentive fee but the investor wants 5% of that fee to go to a particular charity. This results in a net 15% incentive fee to the manager. This one is pretty common for an investor based in NYC that seeds managers and requires them to donate to a religious based charity or institution.   

Will you be able to get this information? Probably not, but if you have an idea of the investor base, you can kinda figure out what is going on. If you run a fund of funds or advisory service, you should hire a former CFO, because they (we) know which investors ask for what. If you really want to know, simply require the manager to sign a “favored nations clause” that gives you the same deal as the best deal found at the hedge fund. Hopefully your manager is honest and will tell you.   

Binish Bulsara


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