What Is a Feeder Fund?
A feeder fund is a pooled-investment vehicle (often one of several sub-funds) that channels all or most of its capital into a single, overarching “master” fund. The master fund holds and manages the combined assets from multiple feeder funds. This master-feeder structure is common in hedge funds and other private investment vehicles because it centralizes portfolio management and trading while allowing different investor types or jurisdictions to invest through separate feeder entities.
Source: Investopedia — https://www.investopedia.com/terms/f/feederfund.asp
Key takeaways
– A feeder fund invests its capital into a master fund; the master fund conducts all portfolio investments and trading.
– Profits/losses at the master level are allocated back to feeder funds pro rata according to their capital contributed.
– Fees (management and performance) are typically levied at the feeder level.
– The primary advantage is economies of scale—lower trading/operating costs through pooling.
– Risks include fee layering, added complexity, tax/regulatory issues, potential liquidity mismatches and loss of fund-level uniqueness.
– Recent regulatory change (SEC, Mar 2017) eased restrictions on certain foreign feeder funds investing into U.S. open-end master funds, subject to conditions intended to protect investors and limit undue influence.
How the master-feeder structure works (simple flow)
1. Several feeder funds (each a separate legal entity) accept capital from investors.
2. Each feeder invests its capital into the master fund (sometimes in cash, sometimes via in-kind transfers).
3. The master fund aggregates capital, the portfolio manager runs a single portfolio and executes trades centrally.
4. Investment returns (or losses) are calculated at the master level and allocated back to each feeder pro rata.
5. Investors in each feeder typically pay fees at the feeder level (management and performance fees) and receive distributions through their feeder.
Example (numeric)
– Feeder A contributes $50m, Feeder B $30m, Feeder C $20m → Master fund total = $100m.
– Master fund returns 10% in a period → $10m profit.
– Distribution: Feeder A gets 50% of profit = $5m; Feeder B gets 30% = $3m; Feeder C gets 20% = $2m.
– Investors pay any applicable management and performance fees according to feeder-level terms.
Why managers and investors use feeder/master structures
Advantages
– Economies of scale: larger pooled capital lowers per-dollar trading costs, execution slippage and operational overhead.
– Single investment policy and portfolio implementation for the manager—simplifies trading and risk management.
– Flexibility to offer different share classes or feeder vehicles for different investor types (U.S. taxable, tax-exempt, non‑U.S., institutional vs. retail) while keeping one central portfolio.
– Can offer differing fee structures, minimums, currency denominations and legal wrappers across feeders without fragmenting the invested portfolio.
Limitations and risks
– Fee layering: potential for fees at both feeder and master level (though most common arrangements charge fees only at the feeder).
– Complexity: multiple legal entities, cross-jurisdictional tax issues, and more complex reporting for investors.
– Loss of distinct strategy: a feeder that had a unique objective may lose that identity when pooled in a master with other feeders.
– Liquidity mismatch / gating risks: master-level illiquidity can affect feeder redemptions; investor-specific redemption rights can complicate master liquidity management.
– Conflicts of interest: manager might favor certain feeders (or investors with side letters) in allocation, fees or liquidity treatment.
– Tax exposure: offshore/onshore structuring can create unexpected tax consequences; tax treatment differs by investor type and elections at the master level.
Tax and regulatory considerations
– Offshore masters: In the U.S. context, it is common for the master fund to be organized offshore so it can accept both U.S.-taxable and tax-exempt investors more flexibly.
– Pass-through/partnership election: If an offshore master elects U.S. tax partnership (or LLC) treatment, then onshore feeders receive pass-through treatment of gains/losses and can avoid double taxation (depending on structure). Tax outcomes hinge on entity type and local tax rules—consult a tax advisor.
– SEC guidance (March 2017): the SEC modified aspects of Section 12(d)(1) of the Investment Company Act to permit certain foreign-regulated funds (foreign feeder funds) to invest in U.S.-registered open-end master funds under conditions designed to prevent undue influence by the master, protect from layered fees, and preserve investor disclosure and transparency. This change eased cross-border marketing and structuring for managers while keeping investor protections. (See Investopedia summary: https://www.investopedia.com/terms/f/feederfund.asp)
Practical steps — Due diligence checklist for investors considering a feeder fund
Before investing in a feeder fund, follow a structured due diligence process:
1. Understand the structure and flow of funds
– Confirm master-feeder relationship; whether the feeder invests 100% into one master or splits across masters.
– Get the legal names and jurisdictions of feeder(s) and master.
2. Review offering documents and agreements
– Private placement memorandum (PPM), prospectus, subscription agreement, limited partnership agreement or operating agreement.
– Pay attention to fee schedules (management and performance fees) and the level(s) at which they are charged.
3. Fees and expense layering
– Confirm whether fees are charged at feeder, master or both. Ask for an illustration of the total expense ratio.
4. Investment strategy and execution
– Confirm the master’s strategy, permissible investments, use of leverage/derivatives, and risk limits.
– Ask who executes trades, how allocations are handled if multiple feeder strategies exist, and whether there are side-letter arrangements.
5. Liquidity and redemption terms
– Redemption frequency, notice periods, gates, suspensions, lock-ups, and any manager discretion to defer redemptions.
6. Tax implications
– Confirm tax treatment for your investor type (U.S. taxable, tax-exempt, non‑U.S.), including possible withholding, PFIC, or unrelated business taxable income (UBTI) concerns. Seek tax counsel.
7. Conflicts of interest and governance
– Review whether the manager controls both feeder and master entities, how conflicts are disclosed and resolved, and what oversight or independent directors exist.
8. Operational and counterparty risk
– Confirm the administrator, fund accountant, auditor, and prime broker. Check the auditor’s reputation and the administrator’s servicing experience.
9. Transparency and reporting
– Frequency and detail of investor reporting, NAV calculation methodology, valuation policies for illiquid assets.
10. Legal/regulatory status
– Is the feeder or master registered with relevant authorities? Are any exemptions used? For cross-border feeders, confirm reliance on any SEC or local regulator relief.
11. Performance record and track record
– Request audited performance history for the master and relevant track record for the manager; check risk-adjusted metrics, drawdowns and attribution.
12. Operational access and oversight
– Determine rights to audit, inspect books, request investor meetings and receive third-party confirmations.
Practical steps to invest (step-by-step)
1. Preliminary screening: assess strategy fit, risk tolerance and minimum investment.
2. Request documents: PPM/prospectus, subscription forms, performance data, audited financials, and legal agreements.
3. Legal and tax review: have counsel and a tax advisor review the documents, especially cross-border tax and regulatory implications.
4. Operational checks: verify administrator, auditor, prime broker, and custodian. Request recent NAV calculations and reconciliations where possible.
5. Negotiate terms (if possible): large or institutional investors may negotiate side letters for preferential reporting, redemption terms or fee breaks—confirm how these are handled fairly across investors.
6. Complete subscription: submit KYC/AML documents, signed subscription agreement and wire funds per instructions.
7. Onboarding and ongoing monitoring: confirm NAV posting, receive regular reports, monitor performance and any notices about gates, suspensions or material changes.
Questions to ask the manager (concise)
– Is this feeder 100% invested in the master? If not, what other investments are allowed?
– At which level are management and performance fees charged? Show a total expense illustration.
– Who are the administrator, auditor and prime broker? Can you provide references or recent audit opinions?
– Are there side letters in place? How are conflicts managed and disclosed?
– What are the redemption mechanics and any historical use of gates or suspensions?
– How is valuation performed for illiquid assets? How often is NAV calculated?
– Have there been material regulatory inquiries or enforcement actions? If so, explain.
Common governance terms to watch for
– Side letters: preferential terms to some investors can create unequal treatment; ensure transparency around material side letters.
– Clawbacks/hurdle rates: for performance fees, understand if and how clawbacks are calculated and enforced.
– Related-party transactions: ensure independent oversight exists for such transactions.
– Audit and valuation committees: independent oversight is a positive sign.
When a master fund is offshore vs onshore—high level implications
– Offshore master: can be tax-efficient for certain investor mixes, may reduce U.S. withholding but increases complexity. Offshore masters often used with onshore feeder for U.S. taxable investors and offshore feeders for non-U.S. investors.
– Onshore master (U.S.-registered): may be necessary for certain regulatory purposes (e.g., mutual funds) or investor preferences. The March 2017 SEC change made certain foreign-feeder to U.S.-master structures more permissible under defined conditions.
Red flags
– Poor or opaque reporting and valuation.
– No independent auditor or weak auditor reputation.
– Manager or master with frequent operational errors or reconciliations out of balance.
– Excessive fee layering or unclear fee illustrations.
– No clear policy on side letters, or many undisclosed side letters.
– Repeated use of gates/suspensions that impede redemptions.
Summary checklist for a final go/no-go decision
– Strategy alignment: Yes/No
– Fee clarity and total expense acceptable: Yes/No
– Tax implications acceptable (after advisor review): Yes/No
– Adequate liquidity and redemption terms: Yes/No
– Strong operations (admin, audit, custody): Yes/No
– Governance and conflict mitigation acceptable: Yes/No
If all or most answers are Yes and you understand the risks, proceed with subscription after legal/tax sign-off.
Further reading and source
– Investopedia: “Feeder Fund” — https://www.investopedia.com/terms/f/feederfund.asp
Note: This content is educational and not tax, legal or investment advice. Always consult your attorney, tax advisor and financial professional before investing in complex pooled vehicles such as feeder/master funds.