Unlocking the Potential of Feeder Funds in Investment Strategies
A feeder fund represents one of multiple sub-funds that pool their investment capital into a unifying umbrella fund, known as a master fund. Within this framework, a single investment advisor manages all portfolio investments and trading activities. This two-tiered structure, known as a master-feeder arrangement, is especially popular among hedge funds for its capacity to assemble substantial investment portfolios by leveraging pooled capital.
Profits generated by the master fund are subsequently distributed among the feeder funds proportionately, based on their contribution of investment capital.
Key Takeaways
- A feeder fund is one of various smaller investment funds that consolidate investor monies, subsequently pooling them under a singular master fund.
- Consolidation of feeder funds into a master fund allows operational and trading costs to be minimized, which, when combined with a larger portfolio, offers significant economies of scale.
- Hedge funds frequently employ master-feeder structures, ensuring fees are proportionately generated and allocated to the feeder funds.
Understanding Feeder Funds
In a feeder fund setup, investors bear the cost of all management and performance fees at the feeder fund level.
The master-feeder fund structure primarily aims to reduce trading and overall operating costs. Significant savings are derived from economies of scale due to the master fund’s access to a more substantial aggregate capital pool from various feeder funds. This setup enables far more efficient operations compared to any feeder fund functioning independently.
This dual-layer fund structure proves especially beneficial when feeder funds share identical investment goals and strategies. However, it might not be appropriate for feeder funds with unique investment strategies, as their distinct characteristics could be overshadowed within a collective master fund.
Structure of Feeder Funds and Master Funds
Feeder funds contributing capital to a master fund are maintained as separate legal entities and might invest in more than one master fund. Often, these feeder funds vary significantly in aspects like expense fees or investment minimums and maintain distinct net asset values (NAVs). Similarly, while a feeder fund can diversify by investing in multiple master funds, the master fund can simultaneously accept investments from an array of feeder funds.
In the United States, it is typical for the master fund to be established as an offshore entity, allowing it to attract investments from both tax-exempt and U.S.-taxable investors. If an offshore master fund elects to be taxed as a partnership or an LLC for U.S. tax purposes, this enables onshore feeder funds to receive pass-through treatment of their portion of the master fund’s gains or losses, thus preventing double taxation.
Global Impact: New Rules for International Feeder Funds
In March 2017, the SEC enacted regulations allowing foreign-regulated companies (foreign feeder funds) to invest in open-end master funds (U.S. Master Fund). This development facilitates global managers in marketing their investment offerings across diverse jurisdictions through a unified master fund.
These revisions updated parts 12(d)(1)(A) and (B) of the 1940 Act, which previously restricted foreign feeder funds from investing in U.S.-registered funds. The SEC enforced these measures to prevent master funds from gaining disproportionate control over an acquired fund, to shield investors from stacked fees, and to avoid over-complicated fund structures that could obscure clarity.
Related Terms: Portfolio Investment, Performance Fee, Operating Costs, Economies of Scale, Master Fund, Net Asset Value, SEC.
