A common issue which often arises is exactly what manner in which the investors actually subscribe to the fund and how the fund actually invests the money. The attached chart (Hedge Fund Organizational Chart) provides a typical hedge fund organizational structure. The chart also details the movement of the management fee, the performance fee, the movements of money, and hedge fund subscriptions or withdrawals.
Hedge Fund Organizational Structure in General
Hedge funds are typically structured as limited partnerships and the investors act as partners in the partnership. The management company is typically structured as a limited liability company. The hedge fund will typically maintain a bank account as well as a brokerage account. [Note: some hedge funds will not maintain a bank account at the fund level.] The bank account is established by the management company and typically the manager will have the authority to direct the fund’s assets.
Hedge Fund Investment Process
Assuming that the hedge fund has a bank account, the investors will subscribe to the fund (after sufficiently completing the subscription documents) by wiring money to the hedge fund’s bank account. The manager will then direct the bank to wire the fund into the brokerage account on the proper date. (The hedge fund offering documents will define when the investors assets are “credited” for the purpose determining the NAV at the time of the contribution.) The assets will become part of the fund’s brokerage account and can be used for investment purposes.
When there is a withdrawal, the opposite process occurs. The manager will direct the broker to wire money to the bank; the manager will then direct the bank to wire money to the withdrawing investor. Management fees and performance fees (named performance allocations in the organizational chart) will be paid to the manager in a similar process. [Note: if the fund does not maintain a fund level bank account the withdrawals and fees will generally be paid directly to the investors or the manager.]
As the chart notes there is the potential for wire fees or other transactional charges which may reduce the amount of incoming or outgoing monies.
Second Signer Services
Can’t a hedge fund manager just wire money from the fund’s bank account to a Swiss bank account?
Questions like these are, unfortunately, the byproduct of increased awareness of instances of hedge fund fraud. In order to preempt such questions many managers have decided to use “second signer” services. These second signer services are usually provided by hedge fund administrators for an additional fee. In general these arrangements require the administrator to sign off on all outgoing wires from the bank and/or brokerage account. We will be detailing these services in another article.
Please let us know if you have any questions on the hedge fund structure or the mechanics of hedge fund subscriptions or withdrawals.