Tag Archives: Hedge Fund Structure

Bunched Orders and Separately Managed Accounts

Separately Managed Account Managers May Bunch Orders for Better Execution

One reason why the hedge fund structure is so popular with investment managers is that a single investment strategy can be implemented in one account.  Separately managed account managers, however, often have multiple accounts and need to execute the same transaction in each of those separate accounts.  Not only is this more time consuming than entering a single trade, there is the possibility that some accounts would receive poorer execution than other accounts (if the trades cannot all be executed for the same prices).  To combat this problem, many brokers offer “bunched” orders which allow a manager to enter into a trade (or series of trades) and then allocate those trades to individual accounts pursuant to a pre-defined allocation method.  In this way trades are allocated to accounts in what may be deemed a more “fair” way.

Types of Bunched Account Allocation Methods

In the event a bunched order is not filled at one total price (called a “partial fill”), there are two central ways to allocate trades to individual accounts from a bunched order – average pricing or high-low.

Average Pricing

Under the average pricing method, the broker’s back end will add up all of the buys or sells at their particular price levels, multiply the trades by the number of contracts (or securities) at each particular price level, and divide by the total number of contracts (or securities) to determine an average price for the whole bunched order.  The trades are allocated to the individual accounts and the price for the trade will reflect the average price.

High low

Under the high-low method, the higher fill prices will be allocated to the higher account numbered clients for both buys and sells, and the lower fill prices to the lower account numbered clients for both purchases and sales.

Issues for CTAs and Investment Advisors

Generally, separately managed accounts fit within the realm of commodity trading advisors and investment advisors.  However, many hedge fund managers are beginning to take on separately managed account clients as well.  The central issue for any of these managers is going to be how the allocation process is described in the investment advisory brochure/contract, disclosure documents or offering documents.  Managers will need to make sure that this issue has been discussed with both the attorney and the broker so that everyone is aware of the actual mechanics of the allocation.  Additionally, I recommend that the broker’s back office review the disclosure documents to ensure that the allocation language is accurate and precise.  If the offering documents state one method and the broker uses another method, there may be some liability for the manager.  Additionally, if the manager is ever subject to examiniation by the SEC, NFA or state securities division, this could be a topic for review.

For hedge fund investors, part of your due diligence process should be to find out whether a hedge fund manager also manages separately managed accounts with the same investment program as the fund.  If so, the investors should ask the manager to explain the allocation process for trades.  While this should be disclosed in the offering documents I have a hunch that this issue is often overlooked by many funds – especially those funds which enter into the SMA agreements after the fund has been in business for a period of time.

Please feel free to contact us if you have any questions on this article or if you are interested in starting a hedge fund.  Other related articles include:

Green Fund of Hedge Funds

The following article on a green fund of hedge funds was originally published on the website www.socialfunds.com and can be found here.  (For more information on environmentally focused hedge funds, please also see our article on Carbon hedge funds.)

Over the Hedge: New Green Hedge Fund of Funds
by Anne Moore Odell

Kenmar plans to launch socially responsible hedge fund of funds for institutional investors.

SocialFunds.com — Kenmar recently announced that it will be launching a new SRI hedge fund of funds, the Kenmar Global ECO Fund SPC Limited, which will be available to investors July 1. Kenmar hopes to tap into the growing interest of investors in environmental, social, and corporate governance (ESG) issues while also achieving its goal of capital appreciation. Continue reading

Hedge Fund Series LLC

The Series LLC

Most hedge funds are structured as either limited partnerships or as limited liability companies (LLCs).  Some hedge funds, however, are structured as series limited liability companies.  The series limited liability company is a relatively new statutorily created entity.  The series LLC is one entity with a group of series each of which is bankruptcy remote from each other series.  This means that the assets of one group or series of assets are protected in the event another group or series of assets becomes subject to suit or other action.  This article discusses the primary uses for the Series LLC in the hedge fund industry, the advantages and disadvantages of the series LLC and other issues involved with the formation of a hedge fund as a series LLC. Continue reading

Hedge Fund Structure – Hedge Fund Organizational Chart

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. Continue reading

Real Estate Hedge Fund Structure

Real estate hedge funds have always been popular and considering the current stock market turmoil and volatility many real estate hedge fund sponsors believe that the time is ripe to offer a real estate product to market weary investors.

Potential Investments

Real estate hedge funds are not limited in their investment strategy and many such funds have different strategies. Many funds purchase real property and hold onto the real property for appreciation. Other funds will purchase raw land and then develop the land or hire other companies (including companies related to the sponsor of the fund) to develop the land. Still other funds will buy properties to manage for current income. Our law firm has handled all of these types of funds, as well as funds which seek to profit from turning around distressed real estate. The real estate may or may not be located in the United States. Other popular strategies include investing in commercial, multi family, general investment quality properties, and properties which have not yet been developed.

Structure and offering documents


The real estate hedge fund structure is similar to a hedge fund focused on trading securities; however there are some important differences. Most importantly, as long as the real estate fund is not investing in any securities (or money market accounts which may, in certain circumstances, be deemed to be securities), the fund will not be subject to the Investment Company Act of 1940 and therefore will not need to fall within either the 3(c)(1) or the 3(c)(7) exemption. This allows the real estate hedge fund a little more flexibility than securities hedge funds. Notably, the fund will need to adhere to the Regulation D requirements of the Securities Act of 1933 only and not the Investment Company Act. This means that the fund will be able to have an unlimited amount of accredited investors and up to 35 non-accredited investors. There is no requirement that investors in a real estate fund be either a qualified client or a qualified purchaser.


Because real estate hedge funds invest in assets which are not easily valued the real estate hedge fund will oftentimes take on a private equity like fund structure. The major characteristics of the private equity fund structure is the (i) closing/drawdown process for capital contributions and (ii) the limit on withdrawals until there is a disposition event. In this way the private equity fund does not have to deal with valuation issues until a value is determined. This helps to prevent the problem of the general partner taking a performance fee on an unknown rise in the asset value. In addition many general partners will also agree to a clawback provision.

An alternative to the strictly private equity structure is for the fund to implement side pocket investments. In their most simplest form a side pocket investment is an investment which is carried on the books to the side. Generally only those investors who were in the fund at the time of the investment (or in some programs, those who opt into the investment) are “owners” of that investment. Generally there will be no performance allocation on any investments in a side pocket account until there has been a disposition of the investment. Then, profits can be distributed to the investors in the side pocket account. Like the private equity structure this allows the fund to invest in hard to value assets without having to actually value the assets until distribution.

The side pocket account also allows a real estate hedge fund to offer a “hybrid” hedge fund product. Managers are finding that hybrid hedge funds are becoming more popular with investors and allow them to sell a product which may potentially resonate with a larger group of potential investors.

There are numerous iterations of a side pocket account and what is allocated to the account and when so we will not go into these in detail here. Once the manager has decided on a general structure the lawyer will work with the manager to identify any questions or issues with the structure. The general rule is that any structural design of the fund can be accommodated within the hedge fund structure – the question is how long it will take the manager and the lawyer to talk through and identify all of the issues of any particular structure.

The real estate hedge fund offering documents will follow the same standard format for hedge fund offering documents which includes a private placement memorandum, a limited partnership (or limited liability company) agreement, and subscription documents.

Real estate hedge fund fees and expenses

Because no two real estate hedge funds are going to have the same investment program and structure of the investment program, there are not any standard fees for these funds. Generally there will be some sort of asset management fee which might range from 1% to 3%. Often a fund will feature a preferred return and then some sort of carry over the preferred return. In this way the performance fees of a real estate hedge fund resemble the structure of the private equity funds. Because of the great variety of fee structures, though, for real estate hedge funds, there is no expected fee structure like for a securities hedge fund.

In addition the asset management fee and performance fees, real estate funds are unique in the fact that they have other expenses which are different from a securities only hedge fund. Specifically there are property acquisition fees as well as fees related to: property managers, leasing and sales agents, construction managers or other services as necessary. It is very common for the general partner to control entities which will provide such services to the fund. Generally the offering documents will note this conflict of interest and/or include a statement that such affiliated entities will be compensated at current market rates.


As with any asset for which there is not a liquid exchange market, valuation of real estate is subjective. Accordingly valuation becomes a major issue for many real estate hedge funds if there is going to be withdrawals from the fund or if the general partner will receive a performance fee for any “paper” gains attributable to increase in the value of the real estate. Valuation becomes less of an issue if there the real estate will be placed in a side pocket account or if there are no withdrawals or performance fees until a disposition event. In the event that a fund needs to implement a valuation policy, the real estate hedge fund manager will basically choose from between three methods of valation (or some combination thereof).

The basic methods of valuation include: (1) book value; (2) outside valuation agent; or (3) by formula. There are advantages and disadvantages to each one of these methods and if you need to have a valuation methodology your lawyer will be able to help you to decide on one of theses methods.


There are always a number of risks involved in any type of hedge fund structure.  One potential risk when dealing with real property is eminent domain.  Depending on the real estate holdings and other investments a fund will make, there are considerations about the ability of the government to reposes the hedge fund holding through the eminent domain process (for more information, please see Washington state eminent domain). This is a risk which should be disclosed in the offering document if it is applicable to the fund’s investments.


Real estate hedge funds are a great structure for the current market and allow non-traditional hedge fund managers an entry point into the alternative investments industry. If you are a real estate professional who is thinking of establishing a real estate hedge fund, please feel free to contact us.

Questions: hedge fund structure

Question: Why is a hedge fund structured as a LP or a LLC instead of a corporation?

Answer: The short answer is that corporations are subject to double taxation (at the entity and investor levels) and that LPs and LLCs can be taxed as partnerships which are taxed only once (as the investor level).

Question: Should a hedge fund be structured as a LP or as a LLC?

Answer: When hedge funds first started out, they were established as limited partnerships. The purpose of forming the fund as a partnership is so that all of the investors and the manager will be subject to partnership taxation. When LLCs became a more prevalent structure in the 80s, there was not a huge rush to form the funds as LLCs. The central reason is that, as a newly formed entity, the law firms were not sure how the courts would view the statutory liability protections of these new entities. As general case law developed, practitioners became more and more comfortable with the LLC as a practicle entity from a liability protection standpoint. However, it was during this time also that many states either developed LLC applicable tax laws or realized that existing laws applied to LLCs.

The central argument for structuring new funds as LLCs is that at the LLC level, there is no liability. In addition to this, the management company will itself be structured as a LLC which provides very strong liability protection for the managers of the management company. At the entity level, the general partner of a limited partnership is potentially subject to unlimited liability; although the fact that the general partner is itself structured as an LLC should provide managers with ample protection. Even so, it is recommended that when a manager is investing in his own fund, he do so as a limited partner. The idea is to keep the management company sufficiently, but not overly, capitalized.