A master-feeder fund is, most commonly, a two-tiered investment structure in which investors deposit capital in a “feeder” fund, which in turn invests in a “master” fund that is managed by the same investment advisor. The master fund is the entity that invests in the market as prescribed in the partnership agreement.
The feeder fund is generally where the capital investing begins: capital (cash or securities) flows from investors into feeders, and these in turn invest all or a portion of that capital into the master fund. The master fund then uses that infusion of capital to invest in securities and thereby generate profit and loss. This profit and loss that the master fund generates is then allocated to all of the master fund’s constituent feeders. From the master fund’s perspective, each feeder can be viewed as an investor.
When you think of a feeder fund investing in a master fund, think of it as a fund buying any other security. For example, the feeder fund (where all the limited partner/shareholder* capital resides) buys “shares” of a master fund, similarly to the way it buys shares of IBM common stock.
One significant operational difference between purchasing common stock and purchasing shares of a master fund is that when a fund buys a share of common stock, it does not “peer into” the underlying income attributes of that stock. Rather, the total return of the stock comprises only price appreciation and dividend income distributions. By contrast, when a fund buys a share of a master fund, it is buying into an investment partnership, and thus all the different income attributes (such as dividends, interest, gains, and tax adjustments) that the master fund generates are passed through to the feeder fund.