We continue series based on the book “The Pragmatic Hedge Fund Manager” started with Part 1 on The History of Hedge Fund Industry. Below is the part introducing Hedge fund types and structure.
Before we move on to legal and other requirements for creating a hedge fund, let’s understand the hedge fund structures that can be constructed. Generally, a hedge fund can be constructed as a domestic hedge fund, a combined offshore and domestic fund or a single offshore fund. The decision regarding which structure to choose for hedge fund construction depends entirely on the implications of the investment and tax considerations.
Domestic Hedge Funds
Domestic hedge funds or single funds are usually constructed as limited partnerships. The investment fund manager serves as the general partner of the hedge fund and investors contribute to the partnership and gain partnership interests. In addition, the domestic hedge funds can also be constructed as or funds, depending on the investors that the fund manager chose to serve. Most commonly, the fund structure is employed by managers when the clients are large corporations and financial institutions. The managers can choose to use both a fund and a fund for the hedge fund construction.
Incubation funds are known as the most appropriate funds for the investment business. An incubation fund is a cost-effective fund structure, which works well in a situation where a manager is looking to manage his own investments for a short period. The time period can range from six months to 12 months. Incubation funds allow investment managers to keep track of their investments and investment strategies, which can later be marketed to interested investors.
Offshore Single Hedge Funds
Offshore single hedge funds are the type of funds that can be domiciled in various jurisdictions that include the British Virgin Islands, Gibraltar, the Isle of Man, Luxembourg, Switzerland and Dubai, to name a few. The offshore single hedge funds are free of taxes as the low tax jurisdictions do not require offshore fund investors to pay corporate-level taxes. Managers typically select jurisdictions with strong regulatory structures; Jurisdictions like the Bermuda and Cayman Islands are generally favored by fund investors due to their powerful regulatory structures.
Combined Hedge Fund Structures
Fund investors can choose to construct individual (completely separate from each other) offshore or onshore hedge funds, depending on the domicile of the interested investors. In addition, the hedge funds can also be structured using combined fund structures such as Side-by-side hedge fund, Master-feeder hedge fund and reverse master-feeder structures.
Side-By-Side Hedge Fund Structures
Side-by-side structures can be onshore and offshore structure. A side-by-side structure is typically used for hedge fund of funds, as this structure requires potential work to affect the trading strategy. In other words, the side-by-side structures use both domestic and offshore funds to make direct investments according to the investment strategy.
Master-Feeder Hedge Funds
The master-feeder hedge fund structure is a combined structure where offshore and domestic funds combine into one central offshore (single) master fund. This structure allows both domestic and international investors to raise capital across the borders.