As a feeder is a partnership that can invest in any investment that it chooses, it’s not limited to invest only in a single master fund. In fact, a feeder can invest in any number of master funds. The subsequent P&L allocations of the master fund back to the feeder may become more difficult to determine. For example, if a feeder is invested in three master funds, with different ownership percentages in each, and earns realized gains from each, determining the amount of realized gain to record for
both book and tax may become a bit more complicated.
On the other hand (and/or at the same time), a master may have more than two feeders invest in it. Any particular master fund may have any number of investee feeders. The equation to determine allocation of P&L now must be extended to include all the feeders, each which may have different investment classes and attributes to consider (see Hot Issues section above).
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When trying to determine how to allocate P&L to the feeders invested
in the master, it’s pretty clear-cut when all investors can receive all P&L.
For economic purposes, you can just take the percentage that the feeders
own of the master fund, and for tax purposes, you can just use an
aggregate allocation method.
But when there’s hot issue gains at the master, allocation to the
feeders can become a little more intricate. Essentially, there are three
main methods for allocating hot issue P&L to the feeders: the “pro rata”
by feeder method, the “look through investment” method, and the
“look through capital” method.
The “pro rata” by feeder method allocates hot issue income the
same as all other income, i.e. no distinction is made. This is common
practice for many firms because either 1) there’s not a material difference
in the proportion of hot issue capital coming from each feeder; 2) there’s
not a material difference in the amount of hot issue income generated
in the master, or 3) it’s too difficult to implement.
The “look through investment” method drills down into each
investor’s capital available to receive hot issue income. This is best
understood by a simple example:
Hedge Funds India
Notice that although each feeder invested 50% each, hot issue allocation is based on “looking through” to each investor’s capital balance and realigning them to 100%. This method would produce a 60/40 split of hot issue income between the two feeders.
A variation of this is called the “look through capital” method. The
main difference occurs when the feeders do not invest 100% into the master, but actually keep some capital down at the feeder, best viewed by an example:
Hedge Funds India
Notice here that the Offshore feeder only invested 50% of its capital, and some of the capital that remained behind is available to participate in hot issue income unrelated to the master fund. In that case, it really is a 75/25 split, and could be a reasonable way for how the master should split hot issue income. In summary, the main things to recognize is whether hot issue income is going to be split by feeder or by investor ratios, and whether the feeders invest 100% in the master.