Some hedge funds combine the money of numerous investors using the master-feeder structure, which includes a feeder fund as one of its key components. Feeder funds are investment funds that investors deposit their money into before the investment manager utilizes the money to invest in a master fund.
Examples and Definition of a Feeder Fund
Hedge fund investors place their money into feeder funds, which feed a master fund with profits. The hedge fund's investment adviser utilizes the hedge fund's master fund, not the feeder fund, to invest in the market. Feeder funds may be seen in the master portfolios of investment management firm BlackRock.
The Treasury Money Market and the Money Market Master Portfolio are the two money market master fund that BlackRock offers to its investors. In another way, investors aren't going to put their money in those funds directly.
An Overview of Feeder Fund Operations
Feeder funds are an essential component of the master-feeder system, one of the most common hedge fund investment methods. As a result, it aims to broaden its investor base and lower expenses by bringing together funds from investors throughout the globe. Feeder funds are where hedge fund investors put their money upfront, and the money from these funds flows into the master fund, where it stays.
The fund's investment management uses feeder funds to invest on behalf of fund members. The master fund's investment objectives and performance are replicated for each feeder fund, and gains are distributed proportionately to the different feeder funds and investors.
Feeder-Fund Types
Two types of feeder funds are common in most master-feeder setups. Taxable U.S. investors can invest in an onshore fund. A limited partnership is the most common form of organization for this fund.
Generally, a general partner oversees the firm, whereas a limited partner does not participate in the day-to-day running of the business. It is also crucial to note that limited partners are solely accountable for their share of investment in the company (or, in this case, the fund). Investors in a hedge fund are treated as limited partners in a master-feeder arrangement.
Benefits of a Master-Feeder System
A decrease in trade expenses
Investment managers can save money on trading costs by bringing together funds from many investors. Trading fees are often a proportion of the transaction amount. Investment managers can avoid paying several trading costs by carrying out a single transaction that impacts many portfolios.
Scale economies
Creating a master fund results in economies of scale, which may be used to reduce operational and transactional expenses in numerous ways? For example, instead of doing risk and security evaluations for different portfolios in multiple feeder funds, the master fund requires only one set of analyses that impact all investors.
A wide range of investors
Master-feeder models allow tax-exempt and overseas investors to participate to maximize the entire pool of money. The onshore and offshore feeder funds also manage tax processes for taxable U.S. investors.
The Drawbacks of Master-Feeder Structures
Accounting complexity
Due to their independent legal status, the feeder funds must maintain their accounting and bookkeeping systems. When the master fund's income and losses have to be allocated evenly, the accounting procedure becomes highly complicated and time-consuming.
Strategic conflicts
In the master fund, several individual investors from feeder funds combine their money. Feeder funds can cater to various types of investors, each with its own unique investing objectives. Therefore, there is a wide range of outcomes for distinct investors from each decision made by the investment manager. Strategic disagreements may arise during the investment management process.
Regional securities limitations
For this reason, the master fund is restricted from purchasing certain types of securities (e.g., foreign government bonds or equities) since investments from overseas investors are also included in the master fund. Investing in certain types of protection is restricted.
International Feeder Funds: New Regulations
To make it simpler for global managers to advertise their investment products in multiple foreign jurisdictions, the SEC decided in March 2017 to enable foreign-regulated corporations to invest in open-end master funds (U.S. Master Fund).
Foreign feeder funds were formerly restricted from being used in U.S.-registered funds under sections 12(d) (1) (A) and (B) of the 1940 Act, which was amended by the letter. For a variety of reasons, the SEC regulated the practice. In the beginning, it aimed to prevent master funds from exercising too much control over an acquired fund.
What Individual Investors Should Know
Because hedge funds primarily utilize it, this strategy is only available to authorized investors in the United States and elsewhere. However, it's worth learning about some of the more complex investment methods nowadays. As an accredited investor, you may find yourself in a feeder fund at some point in the future.
