Meaning of Feeder Fund
An investment feeder fund is one of several sub-funds that invest entirely in a master fund of multiple investment pools. One single investment advisor manages it. By pooling investment capital, hedge funds typically assemble a large portfolio account using a two-tiered investment structure of a feeder and a master fund.
A portion of the profits from the master fund is allocated proportionately to each feeder fund, depending on how much investment capital they contributed to the master fund.
Looking deeper into the meaning of a feeder fund
Investors pay fees and performance fees at the feeder fund level in a feeder fund arrangement.
Feeder fund-master fund structures are primarily used to reduce trading costs and operating expenses. By accessing the large pool of investment capital provided by several feeder funds, the master fund can accomplish economies of scale. This allows it to operate more efficiently than possible for any of the feeder funds investing on their own.
Two-tiered fund structures can be very advantageous when feeder funds have common investment goals and strategies but are inappropriate for feeder funds with unique investment strategies and aims because the feeder fund would lose its unique characteristics in combination with the master fund.
Fund structures: master funds and feeder funds
Feeder funds investing in master funds run independently of the master fund and may be invested in more than one master fund. A master fund’s feeder funds vary significantly in terms of investment minimums or expense fees, and they usually have different net asset values (NAVs). Similarly, a master fund can accept investments from several feeder funds, just as a feeder fund is able to invest in more than one master fund.
It is common for feeder funds to be established as offshore entities based in the United States. In doing so, the master fund will accept investment capital both from tax-exempt investors and from those who are taxable in the United States.
When an offshore master fund elects to be taxed as a partnership or limited liability company (LLC), onshore feeder funds receive the pass-through treatment of their share of the master fund’s gains or losses, thus avoiding double taxation.
The advantages of a master-feeder structure include:
● By trading in mirror portfolios, a master-feeder fund eliminates the need to split tax lots (reduces trading costs).
● Multiple portfolios (pari passu) are easier to manage with a master-feeder structure.
● The master fund general partner’s performance fee will be able to maintain onshore feeders’ tax attributes.
● Together, the funds’ assets can be used to obtain greater financing benefits (for example, higher leverage or lower interest rates on borrowed securities).
International Feeder Funds: New Rules
The Securities and Exchange Commission (SEC) allowed foreign regulated companies (foreign feeder funds) to invest in open-end master funds (U.S. Master Fund) in March 2017, enabling global managers to market their products in different foreign jurisdictions by utilizing master funds.
As a result of the letter, the 1940 Act’s sections 12(d)(1)(A) and (B) have been modified, which previously limited the use of foreign feeder funds for U.S.-registered funds. SEC regulations were imposed for many reasons. In the first place, the master fund wanted to prevent acquisition funds from having too much influence. Moreover, it sought to protect investors in the funds from layered fees and complex fund structures that were difficult to understand.
Example of Feeder Fund
Master Fund X invests in two feeder funds: Fund A and Fund B.
Feeder Fund A has two partners: Partner D and Partner E.
Partner D has invested $50 in Feeder Fund A and is eligible for hot issue gains. Feeder Fund, A investor Partner E, has invested $25 and does not qualify for hot issue gains.
Fund A has $70 invested in Master Fund H.
Feeder Fund B has two investors: Partners P and Q.
They each invested $100 in Fund B.
Both Partners P and Q qualify for hot issue gains.
To determine Feeder Fund A’s hot issue eligibility, Master Fund H divides its total cash investment in Feeder Fund A, i.e., $50 (investment by D), by $250, the sum of the two feeder funds’ hot issue capital. The participation percentage of Feeder Fund A is 20%.
To calculate Feeder Fund B’s hot issue eligibility, Master Fund H divides $200, the total cash investment in Feeder Fund B by its two eligible partners, by $250, Master Fund H’s total hot issue-eligible capital. Feeder Fund B’s participation percentage is 80%.
If Master Fund H receives $500 of gain from hot issues during a period, it allocates 20% of its hot issue again, $100, to Feeder Fund A. Feeder Fund A then allocates $100 (100% of the gain) to Partner D, its sole hot issue-eligible partner.
Master Fund H allocates 80% of its hot issue again, $400, to Feeder Fund B. Feeder Fund Z then apportions $200 (50% of the gain) each to P and Q, who are also eligible to receive hot issue gains.
In conclusion, lenders and Funds must recognize the dynamics of the capital call commitments made by investors in Feeders. This is because lenders can impact the borrowing base and security structure of their facilities. Lenders and Funds can benefit from experienced legal counsel to balance the needs of lenders for adequate security and due diligence concerning investors. In addition, the Fund’s ability to utilize to the fullest extent the available borrowing base of investors in Feeders. A properly structured and documented facility may satisfy both the needs of the lender and the Fund.
