1. Craft Terms Carefully
Hybrid funds often have bespoke, highly variable terms, including for capital calls, liquidity mechanisms, redemption rights, fee structures, governance, reporting, and more. This variability can make it difficult for prospective investors to compare a fund manager’s product against those of competitors, especially where a particular product has multiple share classes.
In crafting these terms, fund managers should consider how each term will apply in practice across the fund’s lifecycle, working closely with fund counsel to facilitate investor due diligence, explain the fund’s key differentiating factors, and articulate its value proposition.
2. Disclose and Mitigate Conflicts
When launching a hybrid fund alongside other fund products, there is potential for conflicts to arise. Fund managers should ensure that these conflicts are disclosed in the fund’s offering documents, and establish robust policies and procedures for mitigating and/or disclosing such conflicts.
Among other things, these include policies and procedures for allocating investment opportunities among multiple investment vehicles with overlapping strategies, determining how to share expenses across products with varying administrative burdens, and minimizing the risk that redemptions disadvantage investors remaining in the fund.
3. Bridge Timing Gaps
Hybrid fund investors often commit capital when they subscribe, but generally do not pay into the fund until the fund manager issues a capital call, which can take as long as a month to complete (including the notice period and transfer). However, investment opportunities can arise in the interim, requiring fund managers to move more quickly than capital calls would allow.
To bridge the timing gap and deploy capital efficiently, fund managers generally are permitted to draw cash from a subscription facility — a short-term loan secured against committed capital — and then make a capital call to repay the facility. In doing so, managers and lenders need to operate with a borrowing base that changes as investors enter and exit the fund.
4. Balance Stability with Flexibility
Hybrid funds aim to strike a delicate balance: holding stable, long-term investments in their underlying portfolio companies, while offering investors the flexibility to enter and exit at set times (for example, quarterly or semiannually).
Striking this balance requires implementing processes for, among other things, calculating the fund’s NAV (including valuation of illiquid assets), managing subscriptions and redemptions, and determining accurate management fees. If considering a liquidity sleeve, managers should calibrate it to withstand periods of elevated redemption activity without unduly dampening overall returns.
5. Diversify Investors and Investments
When a hybrid fund’s investor base is highly concentrated, even a small number of redemption requests can potentially force the manager to liquidate investments at a discount. Similarly, a highly concentrated portfolio can overexpose the fund to volatility and market shocks.
Hybrid fund managers should therefore seek to prioritize diversification — both in their investor base and in their underlying portfolio. Securing a large, diversified group of investors and investments reduces the risk of disproportionate redemption pressure and helps mitigate the impacts of underperforming individual companies or sectors.
