What Is a Master-Feeder Structure?
A master-feeder structure is a device commonly used by hedge funds to pool taxable and tax-exempt capital raised from investors in the United States and overseas into 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 a centralized vehicle known as the master fund. The master fund is responsible for making all portfolio investments and conducting all trading activity. Management and performance fees are paid at the feeder-fund level.
Key Takeaways
- In a master-feeder structure, investment funds are formed from investor capital; these feeder funds, in turn, invest in a centralized master fund.
- Hedge funds commonly use master-feeder structures to accommodate both U.S. and non-U.S. investors.
- The master-feeder structure allows funds to benefit from economies of scale and favorable "pass-through" tax treatment.
How the Master-Feeder Structure Works
The master-feeder structure begins with the investors, who deposit capital into the feeder fund. The feeder fund, containing all the limited partnership/shareholder capital, then 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.Although this two-tiered structure can exist in a variety of forms like "funds of funds" mutual funds the master-feeder structure is especially common among hedge funds catering to both U.S. and offshore or overseas investors. 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.
Composition of Master-Feeders
The average master-feeder structure involves one offshore 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. In other words, the feeders may differ in investor type, fee structures, investment minimums, net asset values, and various other operational attributes.
In this way, the 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 various 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 returns while fund B would receive two-thirds of the returns.Advantages of the Master-Feeder Structure
One significant advantage of the master-feeder structure is the consolidation of various portfolios into one entity. Consolidation allows for reductions of operation and trading costs. A larger portfolio has the benefit of economies of scale. Also, 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.
- Economies of scale
- Tax-advantaged partnership status
- Convenient for both domestic and international investors
- Dividends subject to witholding tax (if offshore)
- Difficulty of setting universal investment strategy
Disadvantages of the Master-Feeder Structure
The primary drawback to the master-feeder structure is that funds held offshore are typically subjected to a 30% 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.