What is a Master-Feeder Fund
A master-feeder fund is a common hedge fund structure utilized to pool taxable and tax-exempt capital raised by United States and overseas investors into a centralized vehicle known as a master fund; separate investment vehicles — otherwise known as feeders — are established for each group of investors. Investors put capital into their respective feeder funds, which ultimately invest assets into the master fund, which is responsible for making all portfolio investments and conducting trading activity. Management and performance fees are paid at the feeder-fund level.
BREAKING DOWN Master-Feeder Fund
The master-feeder fund structure begins with the investor who feeds capital into the feeder fund. The feeder fund, in turn, invests in the master fund, similar to the purchase of any other security. The feeder fund, containing all the limited partnership/shareholder capital, purchases "shares" of the master fund, much like it would buy shares of any company’s stock. The primary difference, of course, is that a feeder fund, by buying into the master fund, receives all of the master fund’s income attributes, including interest, gains, tax adjustments and dividends.
The use of the master-feeder fund structure allows asset managers to benefit from a large capital pool while also being able to fashion investment funds that cater to niche markets.
Structure of a Master-Feeder Fund
The average master-feeder structure involves one master fund with one onshore feeder and one offshore feeder. Feeder funds investing in the same master fund have the option of choice and variation, meaning that they may differ in investor type, fee structures, investment minimums, net asset values and various other operational attributes. This means that feeder funds do not have to adhere to a specific master fund but can function legally as independent entities with the ability to invest in numerous different master funds.
For example, if feeder fund A's $100 contribution and feeder fund B's $200 contribution provided the total investments to a master fund, then fund A would receive one third of the master fund profits while fund B would receive two thirds.
Advantages and Disadvantages of the Master-Feeder Fund Structure
One major advantage of the master-feeder fund structure is the consolidation of various portfolios into one. Consolidation allows for reductions of operation and trading costs. A larger portfolio has the benefit of economies of scale and thus, because of its size, the portfolio has better options when it comes to service and more favorable terms offered by prime brokers and other institutions.
The primary drawback to the master-feeder fund structure is that funds held offshore are typically subjected to a withholding tax on U.S. dividends. There is another disadvantage inherent in the structure, as it pools together a combination of investors that often have a wide spectrum of characteristics as well as investment priorities. Often, the battle to find a middle ground is uphill, if not entirely impossible, as investments and strategies that are suitable to one specific type of investor will be unsuited, if not oppositional, to the requirements of a different type of investor.