Why master feeder structure

The recent rapid growth of the hedge fund industry in Asia has prompted an increasing number of Asian-based hedge fund managers to explore other options for structuring their funds that will afford tax efficient access to the U. Establishing a new fund, or restructuring an existing offshore fund to incorporate a master-feeder structure, is one way in which this objective can be achieved.

A master-feeder fund structure is commonly used to accumulate funds raised from both U. The structure generally involves the use of a master fund company incorporated in a tax-neutral offshore jurisdiction such as the Cayman Islands or Bermuda into which separate and distinct "hub" or feeder funds invest. In this way, the tax impact of an investment in the fund for U.

A typical master-feeder fund structure is as follows:. Click to view larger image. The feeder funds invest all of their assets in the master fund which, in turn, conducts all trading activity. Through their investments in the master fund, the feeder funds participate in the profits of the master fund on a pro-rata basis, in proportion to the amount invested in the master fund.

Management and performance fees are usually payable at the level of the feeder funds. Master-feeder fund structures have long been used by U. S taxable and non-U. In Asia, the use of master-feeder fund structures is not as widespread. However, there has been an increased interest recently among Asian-based hedge fund managers in sourcing investors from the U.

Restructuring an existing hedge fund that accepts investment from non-U. There are variations to the above method for restructuring an existing fund, but the aim is to ensure that a structure is achieved in which the master fund holds all of the underlying fund investments and investors hold interests only in the feeder funds. In a typical master-feeder fund structure, the master fund will make what is commonly referred to as a "check the box" election to be treated as a partnership for U.

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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. The master-feeder structure begins with the investors, who deposit capital into the feeder fund.

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. 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.

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.

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.

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.

Relationships between a master fund and its feeder funds can be complex, as a court case showed. At issue was how redemptions by a feeder fund from a master fund are treated in a liquidation scenario. The same people served as directors of two funds. Also, both funds appointed the same investment manager, administrator, and transfer agent. In , one of the feeder fund's investors submitted a redemption notice. The feeder fund, which held no assets of its own, assumed the master fund would automatically satisfy the redemption request—something called a "back-to-back redemption.

When the original investor submitted a proof of debt, seeking to collect their money, it was rejected by the liquidators of the Ardon Maroon Asia master fund, on the basis that Asia Dragon had never officially submitted a separate redemption request notice to it.