Hybrid fund in the Cayman Islands

Benefits. Hybrid funds offer the flexibility to pursue a wider variety of opportunities set within one vehicle (e.g. a Cayman Islands segregated portfolio company [SPC]). They also offer: (1) better alignment between redemption terms and underlying asset liquidity via side pockets/gates or an evergreen liquidating account model; (2) broader investor appeal combining periodic liquidity and long lock-in bases; (3) continual fundrais­ing that smooths capital inflows versus a fixed-term drawdown fund; and (4) reduction of “run on the fund” risk through gates and redemption limits.

Drawbacks. Hybrid funds create greater legal and administrative complexity than an open or closed-ended vehicle. This is particularly acute in evergreen structures given ongoing subscription/redemption activity. The use of side pockets and gates sometimes causes concern among prospective investors that these tools could mask underperformance. Other drawbacks include harder valuation of illiquid holdings, and conflicts of interest inherent in GP-led continuation transactions.

Redemption mechanics. The interplay of lock-in and notice periods, gate percentage, side pocket triggers, or (in evergreen funds) the liquidating-account waterfall must be precisely documented in the offering memo­randum and constitutional documents. Any ambiguity presents a frequent source of investor disputes.

Side pocket and liquidating-account administra­tion. Fairly allocating side pocket interests as investors subscribe and redeem, valuing illiquid holdings on an ongoing basis, and unwinding a side pocket or man­aging an evergreen liquidating account as assets are realised, are all persistent operational burdens.

Continuation vehicle conflicts. GP-led transactions raise questions that a side pocket does not: independ­ent valuation of rolled-over assets, a fair process for investors choosing between cash-out and rollover, and clear allocation of fees and carried interest between the original and continuation vehicles.

Valuation, reskilling and fees. Managers accus­tomed to liquid, readily priced securities must adapt to management-to-exit investing in illiquid assets, often engaging independent valuation specialists. Co-ordinating fee bases, high-water marks, hurdle rates and realisation-based performance fees are also com­plex once investors hold interests on different terms.

Cayman Islands regulatory compliance: MFA v PFA. The regulatory regime for a hybrid fund will depend on whether investors hold an enforceable right to redeem. Funds granting the right for investors to redeem of their own volition, even if heavily restricted by lock-ins, gates, or a liquidating-account payout, should register as open-ended mutual funds under the Mutual Funds Act (MFA). Funds where investors’ rights to redeem of their own volition is absent should regis­ter as closed-ended under the Private Funds Act (PFA). A hybrid fund with periodic redemption windows and a side pocket typically remains MFA-registered.

For evergreen funds regulations are fact sensitive, depending on whether the liquidating account pre­serves an enforceable redemption right. Typically, vehi­cles offering non-redeemable investment interests, e.g. drawdown PE funds and continuation vehicles, will be registered under the PFA, each with its own audit, and (for PFA funds) valuation and custody requirements.

Governance and investor relations. Institutional investors now expect at least one or two genuinely independent directors on the fund or GP board for good corporate governance, risk management and effective supervisory oversight to oversee not just routine gate and side-pocket decisions but GP-led secondary and continua­tion transactions with sharper conflicts.

Cayman’s core liquidity management tools, e.g. side pockets, lock-ins, gates, and redemp­tions in kind, remain the key elements of hybrid fund structuring. The range built around them has expanded: evergreen funds; SPC-based platforms; and continuation vehicles are now established features of the landscape.

This article was first published in Asia Business Law Journal and be found here Hybrid funds in the Cayman Islands | Law.asia.

This publication is not intended to be a substitute for specific legal advice or a legal opinion. For more information or specific legal advice, please contact:

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