A feeder fund is one critical component of the master-feeder structure—a technique for structuring investment funds—that some hedge funds use to pool the money of many investors. The feeder funds are investment funds that investors put their money into before it’s all put into a master fund, which the investment manager then uses to invest.
Definition and Examples of a Feeder Fund
A feeder fund is a type of investment fund that hedge fund investors put their money into, which then feeds into a master fund. The master fund, not the feeder fund, is what the hedge fund’s investment advisor ultimately uses to invest in the market.
For an example of feeder funds, we can look to investment management firm BlackRock’s master portfolios. BlackRock offers two money market master funds, the Treasury Money Market Master Portfolio and the Money Market Master Portfolio.
An investor wouldn’t actually invest their money directly into those funds. Instead, each of those master funds has a corresponding feeder fund, whose investment results will correspond directly to the investment results of the master portfolio. The master portfolio and its corresponding feeder fund maintain the same investment objectives and strategies.
The relationship between a master fund and its feeder fund is often referred to as a master-feeder structure.
How Does a Feeder Fund Work?
Feeder funds are an integral part of the master-feeder structure that is one of the primary investing strategies used by hedge funds. Its purpose is to pool investments from investors in multiple locations in order to increase their investor pool and reduce costs.
Hedge fund investors deposit their initial investments into the feeder funds, then the money from these feeder funds will flow into a master fund. The fund’s investment manager then uses the money from the various feeder funds to invest on behalf of the fund participants.
The investment objectives and performance feeder funds are identical to those of the corresponding master fund, with the profits divided proportionately to the different feeder funds and investors. In that way, you can think of investing in a feeder fund like investing in an S&P 500 index fund. When you invest your money into the fund, the index fund itself isn’t the true investment, it’s just the vehicle to get you there.
Instead, the stocks from each of the S&P 500 companies are the ultimate destination for your money. And the performance of the index fund itself seeks to be identical to the performance of the index it tracks.
It’s important to note that not just anyone can invest in these feeder funds. For example, if you look at the BlackRock feeder funds we mentioned previously, you’d notice that each one has a minimum initial investment of $100,000,000, which is well outside the realm of possibility for the average investor.
The investors in feeder funds—and hedge funds in general are often institutional investors and extremely high-net-worth individuals. In fact, you must be an accredited investor to invest in hedge funds. An accredited investor can be:
- An individual with earned income of $200,000 or more (or $300,000 or more for married couples)
- An individual with a net worth of more than $1 million
- An individual who holds a Series 7, 65, or 82 license in good standing
- A trust with total assets of more than $5 million
- An entity with total investments of more than $5 million
- An entity whose owners are all accredited investors
Types of Feeder Funds
In most master-feeder structures, there are two types of feeder funds. The first type is an onshore fund for U.S. taxable investors. This fund is generally structured as a limited partnership.
In this type of business relationship, a general partner manages the business operations, while the limited partner doesn’t take an active role in the business operations. And more importantly, the limited partners are only liable up to the amount they invest in the business (or in this case, the fund). In the master-feeder structure, the hedge fund’s investors are limited partners.
The second type of feeder fund is an offshore fund whose investors are foreign investors and U.S. tax-exempt investors. The offshore fund is often structured as an offshore limited liability company (LLC).
Finally, while the master fund isn’t a type of feeder fund, it’s also important to talk about its structure. In many cases, the master fund is an offshore corporation. But in some cases, it may choose to be taxed as a U.S. partnership.
Pros and Cons of Feeder Funds
Lower trading costs
Larger pool of investors
Lower administrative burden
Only open to certain investors
Competing investment strategies
Subject to withholding tax
- Lower trading costs: Feeder funds often have lower trading costs because they don't have to split tax lots and can manage multiple portfolios to avoid paying fees multiple times.
- Larger pool of investors: The master-feeder structure allows a hedge fund to invite a larger pool of investors, since they can have separate feeder funds for both U.S. taxable investors and foreign and tax-exempt investors.
- Lower administrative burden: Not only does the master-feeder structure reduce costs, but it also reduces the administrative burden. You can have one investment manager or management team overseeing the investments of feeder funds that may otherwise have required twice the administrative workload.
- Only open to certain investors: Feeder funds are usually a strategy used by hedge funds, which in the United States are only available to accredited investors. For individuals, you must have an income of more than $200,000 or a net worth over $1 million.
- Competing investment strategies: Because the master-feeder structure often combines investors from different countries, there may be competing strategies at play. For example, the tax strategies that work for U.S. investors may not be ideal for foreign investors. Similarly, certain assets may be appropriate for U.S. investors, but not overseas investors.
- Subject to withholding tax: In the case of an offshore master fund, U.S. dividends are subject to a 30% withholding tax for U.S. investors, with financial penalties if the fund doesn’t withhold it.
What It Means for Individual Investors
As an individual investor, it’s unlikely you’ll come across the master-feeder structure and feeder funds on your investment journey. Because it is a tactic used primarily by hedge funds, it is open primarily to U.S. accredited investors and foreign investors.
That being said, it’s useful to understand some of the advanced investing strategies that exist. First, there may come a day where you qualify as an accredited investor and find yourself investing in a feeder fund. And even if that doesn’t happen, it can be valuable to understand the tactics that institutional investors and high-net-worth individuals use to reduce costs, create efficiencies, and ultimately increase profits.
- A feeder fund is an investment fund that various investors pool their money into, which then feeds into a master fund used to invest.
- A feeder fund is a part of the master-feeder structure that hedge funds often use to pool the resources of both U.S. and foreign investors.
- Hedge fund investing, including investing in feeder funds, is generally only available to accredited investors, or those with a high income or net worth.
- Most master-feeder structures have two feeder funds: one for U.S. taxable investors and the other for foreign investors and tax-exempt U.S. investors.
- Feeder funds help create efficiencies to reduce fees and administrative burdens by combining multiple investment funds into one.