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What Is A Feeder Fund?
Feeder Fund Definition: A feeder fund is an investment fund that feeds into a larger master investment fund. The feeder allows smaller investors to place capital into funds that they otherwise wouldn’t have access to via direct investment. It is similar to a fund-of-funds except the feeder fund exactly mirrors (i.e. it has a pro-rata share) of the holdings of the master fund.
Benefits of a Feeder Fund
The primary benefit of a feeder fund is access. Feeders can be a way into a larger fund and allow individual investors to invest along side pension funds, endowments, or super high net worth individuals.
Let’s run though a simple example. Say you and I are highly interested in Fund ABC’s newest fund. We would love to be limited partners (LPs) in the fund but there is one problem… the fund has a minimum investment size of $5 million USD. They are primarily raising capital from endowments and family offices. Our desire is to write a check of only $250k. Fund ABC (like most funds) will not lower their minimums this much and therefore we are unable to make a direct investment into Fund ABC.
The good news is there still may be a way to investment in Fund ABC. In this instance we can band together with other investors and create a feeder. If we can collectively raise $5m then Fund ABC will very likely be happy to take our capital. They may not want to deal with individual investors asking loads of questions for only a $250k check. But if a feeder with a single point of contact has raised $5m they will likely be more than happy to accept the investment. The feeder model is much easier on the fund than dealing with the paperwork and diligence questions resulting from lots of individual investors writing small checks.
Related to getting access, the other main investor benefit of feeder funds is the ability for investors to gain diversification. If I have $1 million to allocate, I very likely do not want to place it all with one sponsor. Instead I’d rather diversify across sponsors. The ability to access funds at a lower minimum investment size and the corresponding diversification investors can achieve are the two big reasons investors like feeder funds.
Drawbacks of a Feeder Fund
We’ve talked about the pros of a feeder fund. What are the cons of a feeder fund?
The main drawback is cost.
Back to our example of Fund ABC. Let’s assume this fund has a typical waterfall structure of 2/20. This means they charge 2% per year for management fees are entitled to 20% of the profits.
A feeder will typically charge an additional 1% management fee. Why? The feeder costs money to start-up and maintain and therefore will charge investors an additional 1%.
You’re now incurring 3% per anum in management expenses. That is steep and will eat into your financial returns. The investor will have to weight the pros and cons. Is the access and diversification worth the added cost?
Feeder Funds Summary
To recap, a feeder fund is an investment vehicle that feeds into a larger fund. A feeder is typically created because investors cannot access the larger fund directly. Most commonly this is because of high minimums. Feeders provide investors with access and diversification but it comes with a higher cost.