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Investment Basics: Cayman Islands Mutual Fund Structure

As our investment fund practice continues to grow, we’re thrilled to bring you a series of articles focused on the fundamentals of investment funds and best practices. In our previous piece, “Investment Basics: Cayman Mutual Funds” we explored why the Cayman Islands remain a global leader in fund regulation and how their flexibility allows fund managers to design structures tailored to investors’ needs.In this article, we’re taking it a step further.

We’ll walk you through the different ways fund managers can structure mutual funds, especially when juggling the challenges of operating across multiple jurisdictions. Along the way, we’ll tackle some of the most common questions about fund structuring, providing clear, practical insights to help you make informed decisions for your fund and your investors.

Stand-Alone Fund

As highlighted in our previous article, “Investment Basics: Cayman Mutual Funds,” and defined under the Mutual Funds Act (2021 Revision) of the Cayman Islands (the “Act”), a mutual fund refers to a company, unit trust, or partnership that issues equity interests with the purpose of pooling investor funds. The aim is to spread investment risks while enabling investors to receive profits or gains from the management or disposal of investments. This flexibility is a cornerstone of the Cayman Islands’ regulatory framework, making it an attractive jurisdiction for fund managers.

One of the simplest and most straightforward mutual fund structures is the Stand-Alone Fund. A stand-alone fund operates independently and does not rely on a feeder or master fund structure. It pools investments directly from investors and deploys those funds into a diversified portfolio of assets. This structure is often favoured for its simplicity and cost-effectiveness, particularly for fund managers who are working within a single jurisdiction or managing a smaller investor base.

In this section, we’ll explore the key characteristics of a stand-alone fund, why it might be the right choice for certain fund managers, and the considerations to keep in mind when deciding if this structure aligns with your investors’ needs and your overall fund strategy.

A stand-alone fund is a versatile structure that appeals primarily to non-US investors, leveraging the Cayman Islands’ regulatory advantages to attract global capital. However, its flexibility doesn’t end there. With careful planning, stand-alone funds can also accommodate US-domiciled tax-exempt investors, such as pension funds, charitable organizations, and endowments. These investors are often drawn to structures that minimize exposure to unrelated business taxable income (UBTI), a key consideration for tax-exempt entities. This adaptability makes the stand-alone fund an attractive option for fund managers looking to serve a diverse investor base without overcomplicating their structure.

At its core, the offshore stand-alone structure is exactly what its name suggests, a single, independent fund vehicle that pools capital collectively from all investors. By eliminating the need for additional entities, such as feeder funds or master funds, this structure keeps things streamlined. For fund managers, this means reduced administrative costs and fewer regulatory hurdles to navigate, which can be especially appealing for newer funds or smaller-scale operations. Despite its simplicity, the stand-alone fund still offers robust opportunities for diversification and professional portfolio management, making it a practical choice for many.

One of the main reasons managers opt for a stand-alone structure is its suitability for funds that are not initially designed to accommodate US taxable investors. By focusing on non-US and US tax-exempt investors, managers can avoid the complexities associated with US tax reporting and compliance. This simplicity not only benefits the manager but also provides clarity and ease of investment for potential investors, enhancing the fund’s appeal in international markets.

Overall, the stand-alone fund is an excellent option for managers looking to establish a straightforward, cost-effective structure while retaining the flexibility to attract a broad range of investors. In the following sections, we’ll explore other fund structures, comparing their features, advantages, and scenarios where they may be preferred over a stand-alone approach.

Master-Feeder Structure

The master-feeder structure is one of the most commonly used frameworks in fund management, especially for blending US taxable and non-US investors within the same investment strategy. This structure combines a master fund, which handles all trading and investments, with one or more feeder funds, which channel contributions from different groups of investors into the master fund.

Under the Act,master fund is defined as a company, partnership, or unit trust established in the Cayman Islands that issues equity interests, conducts trading activities, and implements the overall investment strategy for its feeder fund(s). A feeder fund is a mutual fund that invests more than 51% of its assets in a master fund, either directly or through an intermediary. Together, these components create a seamless system where all investors benefit from the same pool of assets, regardless of their tax or jurisdictional status.

This structure is especially popular for funds targeting a mix of investor types. Typically, an offshore feeder fund is set up to attract non-US investors and US tax-exempt entities, such as pension funds and charitable organizations, while an onshore feeder fund is created for US taxable investors. Both feeder funds channel their investments into the master fund, which acts as the central trading entity.

What’s great about the master-feeder structure is its flexibility. If you’re launching a new fund, the offshore feeders and master fund can be set up alongside an onshore feeder, creating a synchronized structure from day one. However, if you already have a standalone domestic fund in the US, you can integrate the offshore feeders and master into the existing arrangement. In this case, the assets of the existing US fund are contributed to the offshore master fund, which then takes over all trading and investment activities moving forward. The offshore feeder fund collects investments from non-US and US tax-exempt investors, “feeding” them into the master, while the onshore feeder continues to accommodate US taxable investors.

This approach not only simplifies operations but also delivers real advantages. By consolidating trading activities into the master fund, managers avoid the need to allocate trades across multiple entities, saving time and reducing complexity. Additionally, the master-feeder structure eliminates duplicate documentation with counterparties and may even enhance opportunities for leverage, making it more efficient and cost-effective compared to a side-by-side fund structure.

In short, the master-feeder structure is a versatile, globally recognized solution that helps fund managers cater to diverse investor groups while maintaining operational efficiency. It’s a particularly strong choice for managers looking to expand internationally or offer a tax-efficient solution for investors across different jurisdictions.

Mini-Master Structure

The mini-master structure is a flexible and cost-effective solution for fund managers exploring the benefits of offshore fund vehicles without committing to the full expense and complexity of a traditional master-feeder setup. It’s especially popular for managers who want to accommodate a smaller group of investors or test the waters with an offshore structure before scaling up.

In this setup, a single offshore fund is created and is often designed to block unrelated UBTI for US tax-exempt investors while remaining attractive to non-US investors. The offshore fund invests directly into the existing US fund, which serves as the master vehicle. This eliminates the need to transfer ownership of assets from the domestic fund, reducing both administrative burdens and restructuring costs. For fund managers, this simplicity can be a major advantage when looking to create an efficient and streamlined investment offering.

One of the key appeals of the mini-master structure is its flexibility. It allows fund managers to introduce an offshore component without requiring a complete overhaul of their existing operations. For example, managers with an existing standalone US fund can seamlessly add the offshore fund to their structure, letting both funds work together to attract a broader range of investors.

Occasionally, you may also encounter “reverse mini-masters,” where the roles are flipped, and the US fund invests into an offshore master vehicle. This can be useful in cases where the offshore fund was the original entity or where the underlying assets are better suited to being held outside the US. Like the traditional mini-master setup, reverse mini-masters offer fund managers a creative way to manage cross-border operations efficiently.

Ultimately, the mini-master structure provides a simple and cost-conscious way to introduce offshore investment opportunities. Its streamlined approach makes it a great choice for managers looking to expand their investor base while maintaining operational efficiency and flexibility.

Parallel Fund Structure

Sometimes called “side-by-side funds,” parallel funds are a creative solution for fund managers looking to accommodate both US and non-US investors with different tax needs. For this article, we’ll stick with the term “parallel fund” to keep things simple.

In a parallel fund structure, US taxable investors typically invest in an onshore fund, such as a limited liability company (LLC) or limited partnership formed in the United States. At the same time, non-US investors and US tax-exempt entities, like pension funds and charitable organizations, invest through an offshore fund, often set up as a corporation in a tax-neutral jurisdiction. Despite being separate entities, these funds operate in tandem, following the same investment strategy and, whenever possible, applying the same fee structure.

One of the biggest advantages of a parallel fund structure is its flexibility. By keeping the onshore and offshore funds as distinct entities, fund managers can tailor their tax strategies to suit each group of investors. For example, a tax-efficient approach for offshore investors might create complications for US taxable investors if used in a shared structure, like a master-feeder. Parallel funds solve this problem by keeping the operations separate while ensuring both sets of investors benefit from the same overall strategy.

That said, parallel funds do require some extra coordination. Since the onshore and offshore funds are independent, trades must either be executed simultaneously or split across both entities by a prime broker. This additional administrative step can create small differences in performance between the two funds, whether due to timing, fees, or minor portfolio variations. Managers also need to stay mindful of any potential conflicts that might arise if the portfolios start to drift apart.

While parallel funds are less common than they once were, they’ve seen renewed interest in specialized areas such as private equity or venture capital, where certain investments, like those tied to regulated industries or unique local markets, may have restrictions that exclude US taxable investors. For example, offshore investors might prefer opportunities in emerging markets where local laws or counterparties limit participation by US-based entities. In such cases, parallel funds offer a practical way to keep things compliant while ensuring all investors can participate effectively.

Ultimately, the parallel fund structure provides fund managers with the tools to meet the specific needs of diverse investor groups. While it comes with some added complexity, the ability to create tailored solutions for both onshore and offshore investors makes it a valuable option for the right investment strategy.

Hybrid Fund Structures

Sometimes, a single fund structure isn’t enough to meet the diverse needs of investors or accommodate a manager’s specific strategy. That’s where hybrid structures come into play. By combining elements of different setups, such as master-feeder and parallel funds, hybrid structures offer fund managers the flexibility to tackle unique challenges, like handling investors from a variety of tax environments or managing complex investment strategies.

A common example of a hybrid structure combines an offshore master fund with both an offshore feeder fund (for non-US and US tax-exempt investors) and a parallel onshore fund (for US taxable investors). This setup lets the offshore master fund pool capital from the feeder fund while keeping the onshore fund separate for tax-specific considerations. The result? Managers get the operational efficiency of a master-feeder structure while enjoying the flexibility of parallel funds.

Hybrid structures are also useful for multi-strategy funds. For instance, a fund might have a core hedge fund strategy alongside a private equity “side pocket” for longer-term investments. By creating a separate vehicle for the private equity portion, the fund can maintain liquidity for its main strategy while still offering investors access to unique growth opportunities.

Of course, hybrid structures require careful planning. Since these arrangements can be more complex, managers need to work closely with legal and tax advisors to ensure compliance and transparency. Clear communication with investors is also key to making these structures work smoothly. But for fund managers looking to tailor their approach to meet investor needs or market demands, hybrid structures can be an excellent solution.

If you’re a promoter, director, investment manager, or general partner of a Cayman fund and you’re wondering how these structures might work for your fund or whether they align with your business needs, don’t hesitate to reach out to your legal counsel at Vale Law. We’re here to provide guidance, clarify regulatory requirements, and help you craft a fund structure that meets your goals while ensuring compliance with Cayman Islands regulations.

Shelley Do Vale: shelley.vale@valelaw.ky

Santiago Mtnez-Carvajal: sc@valelaw.ky