What is a Feeder Fund?

Key Highlights

• Feeder funds pool capital and invest it in master funds. A master fund invests in the market, manages portfolios, and trades securities.
• A feeder and a master fund are separate legal entities.
• Feeder may invest in more than one master fund, and master funds may accept investments from any number of feeder funds.
• Fees and performance fees are paid at the feeder fund level.

Understanding Feeder Fund

In a feeder fund, capital is pooled and invested into a master fund. Master funds invest in the market, manage portfolios, and trade securities. An investment advisor handles all investments. A hedge fund usually assembles a large portfolio account by pooling investment capital using a two-tiered investment structure. Profits from the master fund are allocated proportionately to feeder funds based on their investment capital contributions.

How Feeder Fund Works?

A feeder-master fund structure is primarily used to reduce trading costs and operating expenses. With several feeder funds providing investment capital, the master fund can achieve economies of scale. As a result, it operates more efficiently than any of the feeder funds investing on their own.

If feeder funds have similar investment goals and strategies, two-tiered fund structures can be very advantageous. However, feeders with unique investment strategies and aims are inappropriate since they would lose their unique characteristics when combined with the master fund.

Feeder Fund Example

Let's understand how a feeder fund works with an example:

Consider a scenario where there are three countries: A, B, and C.

A and B residents find country C an attractive investment location.

A global investment house sets up two Feeder Funds in Countries A and B and a Master Fund in Country C to take advantage of this demand.

Feeder funds collect investment capital from residents of countries A & B and invest it in Company C's Master Fund.

The master fund invests this money in County C's financial markets and distributes profits from these investments proportionally to the investor.

It provides cost savings to the fund house because of its feeder-master structure. A Feeder structure saves the fund the cost of employing a dedicated research and investment team in each of countries A & B by instead relying on a central team in Country C to make investments.

Structure of Feeder Funds

Feeder and master funds are managed in a two-tiered manner. Feeder funds get money from direct investors and invest it in multiple master funds or one. Fees for fund management are based on the feeder. They're determined by the expense ratio of the master funds they invest in.

There is no requirement that feeder and master funds be located in the same geographic location. These funds can also be invested in US-based master funds. By investing in a feeder fund, one can reap numerous benefits by investing in international loans and stocks and removing the geographical barrier.

In the same way as the feeder fund, the master fund may invest money from a variety of sources. Feeder investors receive profits based on the weight of their investments. Master funds in which a feeder invests may not all have the same expense ratios or Net Asset Values.

Advantages of Master-Feeder Structure

A master-feeder structure has the following advantages:

• A master-feeder eliminates the need to split tax lots (reduces trading costs) by trading mirror portfolios.
• A master-feeder structure makes it easier to manage multiple portfolios.
• Onshore feeders' tax attributes can be maintained by the master fund general partner's performance fee.
• By pooling assets, the funds can achieve greater financing benefits.

Key Points to Consider While Investing in a Feeder Fund

• Choose a fund that invests in multiple master funds with similar investment objectives.
• Investing in foreign master funds is beneficial as it allows you to invest without much friction in foreign markets.
• Feeder-master fund structures are used to build larger investment portfolios.
• Investors pay all management fees and other fund fees at the feeder fund level.
• Depending on the percentage of investment capital contributed to the master fund, profits are divided among feeder investors.
• A master fund can have any number of feeder funds.
• By having access to a large pool of investment funds, the two-tier structure helps achieve economies of scale. It is less expensive to operate the master fund than to operate the feeder separately.
• In situations where the feeder and the master funds have similar investment goals and strategies, a two-tier structure may be beneficial. In contrast, a feeder with its own investment goals and strategy would not benefit from the structure.
• Feeder funds and master funds are separate legal entities. In the US, master funds are established as offshore entities so that they can accept investments from a variety of investors. A feeder may also invest in more than one master fund.
• In the same way that a feeder company may invest in more than one master fund, a master fund may accept investments from as many feeder companies as it wishes.

Conclusion

A feeder fund is one of many sub-funds that invest entirely in a master fund. Every investor gets a share of the profits from the master fund based on how much they invested. These feeder-master fund structures are mainly used to reduce trading costs. Through several funds, the master fund can access a large pool of investment capital.