Hybrid funds in the Cayman Islands

A hybrid fund combines features of open-ended hedge fund and closed-ended private equity structures. Open-ended funds allow periodic redemptions at net asset value, focusing investments into liquid portfolios. Closed-ended funds lock up capital for a fixed term and focus on investments into illiquid strategies (e.g. PE funds and private credit funds), with assets that cannot be sold quickly without substantial loss of value.

Hybrid funds sit between the two, and the category has broadened as hedge fund and private equity models have blurred. Traditionally, this means an initial lock-in period combined with limited ongoing redemption rights, supported by side pockets, gates, suspensions and redemptions in kind.

Evergreen funds have emerged as a distinct sub-category. These are perpetual, open-ended vehicles borrowing closed-ended features such as capital calls and liquidating accounts to satisfy redemptions over time. Continuation vehicles and GP-led (general partner) secondaries add a further variant, blending primary commitments, secondary purchases, and co-investment rights in one vehicle.

Key benefits and drawbacks

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 in these structures 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.

Structuring challenges

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 have to 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 traditional hybrid fund with periodic redemption windows and a side pocket typically remains MFA-registered.

The regulatory regime for evergreen funds is 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 hybrid structuring toolkit expands

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.

Vanisha Harjani is a partner, and Yuri Zhang and Frost Wu are associates at Loeb Smith Attorneys in Hong Kong. This article was contributed by Loeb Smith Attorneys.