By Elana Duré
- More newly formed activist hedge funds are choosing to raise capital on a deal-by-deal basis instead of through a main fund to overcome market challenges, industry sources said.
- Investor preference has recently shifted toward direct deals and co-investments as limited partners seek more transparency surrounding the catalysts and time horizons of the stakes that fund managers build, one industry source said.
- Structuring investments through special purpose vehicles is attractive to investors because it allows them to pick and choose what to invest in, rather than putting faith in managers and all their investment decisions, one industry source said.
As the number of institutional investors seeking co-investment opportunities continues to rise, more newly formed activist hedge funds are choosing to raise capital on a deal-by-deal basis instead of through a main fund to overcome market challenges, industry sources said.
Structuring investments through special purpose vehicles could be a way to differentiate from the crowd amid current hurdles in raising capital and attracting limited partners, they added.
Activist investor Mantle Ridge was one of the first to structure deals only through SPVs. The fund, which was founded in 2016 by former Pershing Square Capital Management partner Paul Hilal, raised about $1.2 billion for its first investment in railroad company CSX, marking returns of about $700 million just five months after a March 2017 settlement, Institutional Investor reported at the time.
Since then, newcomers such as Caligan Partners and Ziba Capital Management have adopted similar structures. Caligan, founded in 2018, previously told Reorg it plans to raise capital on a deal-by-deal basis. Ziba, founded in 2019, is doing the same, though eventually plans to raise capital for a main fund as well, according to a person familiar with the situation.
Investor preference has recently shifted toward direct deals and co-investments as limited partners seek more transparency surrounding the catalysts and time horizons of the stakes that fund managers build, said David Frank, CEO of alternative asset placement agent platform Stonehaven.
The SPV model is attractive to investors because it allows them to pick and choose what to invest in rather than putting faith in managers and all their investment decisions, Jeffrey Rosenthal, a partner at accounting firm Anchin, said. In other words, it allows the investor to do a “great deal of due diligence” before agreeing to financially back an investment, said Ali Dibadj, an analyst at Bernstein.
Another attractive feat for investors is that SPVs often have lower fees than the traditional 2 and 20 structure for main funds, though there is a range, Frank said. However, this is a downside for the activist, who could potentially make less money using this model.
There isn’t an average co-investment size, as it depends on the size of the investors and how large a position they want to take in the fund, said Mark Aldoroty, head of prime services and collateral funding and trading at BNY Mellon’s Pershing.
Capital Raising Pros and Cons
Activist newcomers might choose to raise capital on a deal-by-deal basis to help build a track record, industry sources agreed. It’s easier to have a “single compelling idea” to pitch to a group of limited partners than to pitch an unknown manager, Dibadj said.
For others, choosing to raise capital on a deal-by-deal basis is a reflection of today’s current flat market, Frank said. An activist fund manager confirmed this sentiment, telling Reorg the firm would be raising capital for a main fund if it was still “the golden age of hedge funds.” However, because more investors are redeeming their capital from hedge funds, the activist said raising capital on a deal-by-deal basis was safer. Managers are able to tailor the terms for each SPV, often setting longer lockup periods and barring investors from redeeming their capital from the fund before a certain date.
The investor base is varied and can include other managers that want to leverage specialist managers with unique deal flow or operations in different geographies, Frank said. Because the structure requires investors to move quickly, it also often includes investors with fewer layers of internal approval such as high-net-worth individuals, family offices, fund-of-funds, and fund-of-managed accounts, Aldoroty said.
Generally, it takes managers several months to get investors comfortable with their strategy and deal flow, Frank and Aldoroty agreed. Once the relationship is built, Frank said, capital raising can take as short as a few weeks to as long as six months.
However, the SPV model does not come without its challenges. Activists might lose opportunities if they cannot deploy capital immediately, said Eleazer Klein, a partner and co-chair of the shareholder activism group at Schulte Roth & Zabel.
In addition, raising capital on a deal-by-deal basis often means the activist must spend more time fundraising and less time executing ideas, Dibadj said. Also, this model is expensive because it produces more administrative and audit costs, which can infringe on returns, said Rosenthal.
Raising capital for single ideas has not replaced commingled funds, and most hedge fund managers only provide co-investments as side benefits, Aldoroty said.
Some of the industry’s most prominent players, including Nelson Peltz’s Trian Fund Management, Bill Ackman’s Pershing Square, Doug Braunstein’s Hudson Executive Capital and Glenn Welling’s Engaged Capital, have previously relied on SPVs to raise money.
Nonetheless, Frank anticipates SPVs will become increasingly more popular among managers, while Rosenthal said it will probably be more apparent in the private equity space than the hedge fund arena.
The person familiar said he thinks it’s good to have a main fund and SPVs because the main fund enables activists to act on situations right away, oftentimes giving them a bigger pool of money to play with, but SPVs provide value when the activist is looking at a particularly costly opportunity with the need to raise additional capital.