Master-Feeder and Offshore Fund Structures

A hedge fund manager typically has investors with very different tax situations: US taxable individuals, US tax-exempt entities like pensions and endowments, and non-US investors. Running one commingled fund for all of them creates problems, because certain US tax rules — particularly around "unrelated business taxable income" for tax-exempts and US tax filings for foreign investors — would otherwise contaminate the whole pool. The master-feeder structure solves this by splitting the investor base into separate entry points while still running one investment strategy.

In this structure, a US limited partnership ("onshore feeder") accepts US taxable investors, and a fund domiciled somewhere like the Cayman Islands ("offshore feeder") accepts tax-exempt and non-US investors. Both feeders then invest essentially all their capital into a single "master" fund, also usually offshore, which is where the manager actually executes the strategy — buys the securities, runs the book, takes the risk. Investors experience the feeder that suits their tax profile, but behind the scenes their money is pooled together and traded as one portfolio, which keeps trading efficient and avoids running duplicate strategies.

The tradeoff is complexity and cost: master-feeder structures need separate administration, separate audits in some cases, and legal work to keep the entities properly documented, all of which shows up in the fund's expenses. They also introduce a subtlety around fees and allocations — since feeders can have different investor bases and sometimes different fee terms, the manager needs a clean method for allocating the master fund's gains, losses, and expenses back down to each feeder in proportion to its ownership share, so that no group of investors is subsidizing another's tax or fee arrangement.