What Is a Feeder Fund?
Let me explain what a feeder fund is directly to you. It's one of several sub-funds that channel all their investment capital into a larger umbrella fund called the master fund. A single investment advisor manages all the portfolio investments and trading for this master fund. You'll see this two-tiered structure often in hedge funds, where it helps assemble a bigger portfolio by pooling capital from multiple sources.
Once the master fund generates profits, those are split and distributed back to the feeder funds based on the proportion of capital each one contributed. This setup keeps things straightforward and efficient.
Key Takeaways
- A feeder fund is one of many smaller funds that pool investor money into a single centralized master fund.
- Combining feeder funds into a master fund reduces operation and trading costs, and the larger portfolio benefits from economies of scale.
- Hedge funds frequently use master-feeder structures, with fees pro-rated and distributed to the feeder funds.
Understanding Feeder Funds
In this arrangement, you as an investor pay all management and performance fees at the feeder fund level. The main goal here is to cut down on trading and operating costs overall. The master fund gains from economies of scale by accessing a big pool of capital from various feeder funds, which lets it run more cheaply than if each feeder fund invested independently.
This two-tiered structure works well when feeder funds have similar investment goals and strategies. But if a feeder fund has a unique approach, it might not fit, as those distinct traits could get diluted in the master fund's mix.
Structure of Feeder Funds and Master Funds
Feeder funds act as separate legal entities from the master fund and can invest in more than one master fund if needed. Different feeder funds in the same master fund can vary a lot—in expense fees, minimum investments, or net asset values (NAV). Just as a feeder fund can spread across multiple masters, a master fund can take investments from numerous feeders.
For those operating in the U.S., the master fund is often set up offshore. This allows it to accept money from both tax-exempt and taxable U.S. investors. If the offshore master fund chooses to be taxed as a partnership or LLC for U.S. purposes, onshore feeder funds get pass-through treatment on gains and losses, avoiding double taxation.
New Rules on International Feeder Funds
Back in March 2017, the SEC made a ruling that lets foreign-regulated companies—those foreign feeder funds—invest in open-end U.S. master funds. This change makes it simpler for global managers to market their products across different countries using a master fund setup.
The ruling adjusted sections 12(d)(1)(A) and (B) of the 1940 Act, which had limited foreign feeders into U.S.-registered funds before. The SEC did this to stop master funds from gaining too much control over acquired funds, to shield investors from extra layered fees, and to avoid fund structures becoming overly complicated and hard to grasp.
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