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While seeding activity remained strong overall during 2019, volume was down modestly year over year, particularly in strategies that traditionally are able to command the largest seed investments given their significant investment capacities. This dynamic has been observed in past circumstances when the markets were perceived to be expensive, such that strategies which are highly correlated to overall market performance become somewhat less desirable as investors foresee an imminent correction. However, the return of extreme volatility in the first quarter of 2020 due to the COVID response may well provide an opening for these strategies, and there are already signs in 2020 of an uptick in the seeding of these products.
While fewer in number, traditional long/short and macro strategies remained a significant share of seed investment activity (particularly in terms of their share of the aggregate dollars invested in seed investments), as did other strategies which tend to have significant investment capacity. Credit focused strategies also received significant attention from seed investors, as did other “hybrid” strategies whose investment composition includes allocations to both liquid and positions. Indeed, seeders are increasingly providing medium duration capital (through the lock-up of the seed investment) that can provide an anchor base of capital to support the ability of other LPs to access liquidity despite illiquids being a significant portion of a fund’s portfolio, thus creating a stronger offering for the seeded product.
As in prior years, strategies that are more resistant to fee compression pressures were in high demand, as were strategies that are able to provide favorable liquidity to their investors – though a notable increase in investor level gates was observed in funds that were seeded, reflecting broader industry trends (including the broadening of investment mandatesinto illiquids and less liquids as mentioned above).
With capital formation remaining a challenge for new funds, managers who were able to obtain a seed investment had a considerable head start for their businesses and ability to attract additional investors. The persistence of two-year (and longer) lock-ups as the market standard incentivized seeded managers to invest greater resources in their businesses and orient their decisions – both investment and operational – with an eye towards the long-term.
Our 2019 data suggests that the core economic terms of seed deals continue to reflect a trend toward more “manager-friendly” structures; two key continuing trends are seeders’ willingness to (i) bear some of the start-up costs of the new business, and (ii) remain subject to a liquidity profile (post-lock-up) that is similar to other investors in the fund.
Our 2019 study continues last year’s approach of comparing our most recent data with our historical data sets, highlighting relevant market trends. As noted in the past several years, our data suggests an increased willingness of seeders to be responsive to managers’ concerns of how to provide the best launchpad for their new businesses. This improved alignment between seeders and managers will help ensure that there remains a robust opportunity set for seeders and managers alike. Accordingly, we expect that seed capital will remain a key factor in a new manager’s path to success.