Hedge Fund Structre

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S TRUCTURING O FFSHORE H EDGE F UNDS


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Overview : Table of Contents:

How are hedge funds structured? 3

Categories of Investors 4

Hedge Fund Investor Composition 5

Taxable U.S. Investors 6

Tax-Exempt U.S. Investors 7

Why do some investors go offshore? 8

Offshore Jurisdictions Why do hedge 9Funds set up entities in the Cayman Islands?

Breakdown of Hedge Fund Domiciles 10

Anti- Money Laundering and Other Know 11Your Customer Regulation and Supervision

Addressing the Concerns of Tax-Exempt U.S. 12Investors

Non-U.S. Investors 13

Accommodating the Conflicting 14Needs of U.S. and Non-U.S. Investorsin a Hedge Funds Structure

How does a hedge fund accommodate 15the interests of different investors at thesame time?

Stand-Alone Structure 16

Side-by-side structure 17,18

Advantages and Disadvantages 19of a Side-by-Side Structure

Master-Feeder Structure 20, 21, 22

Acknowledgements 23

A principal concern when structuring a hedge fundis to provide the most favorable tax result for theinvestors and the fund manager itself.

Because U.S. corporations are subject to incometax on investment income as well as businessincome, tax-exempt U.S. investors prefer to investin non-U.S. corporations, which are not subject toincome tax in the jurisdiction in which they resideand which generally can avail themselves of asafe harbor from U.S. taxation if they receive only

investment and trading income.

This presentation focuses on the structure ofoffshore vehicles and the general business andregulatory environment in popular offshore

jurisdictions, such as the Cayman Islands, theBritish Virgin Islands, Bermuda, and Ireland.

Structuring Offshore Hedge Funds

Contents


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In structuring a hedge fund, aprincipal concern is to provide themost favorable tax result for theinvestors and the fund manager itself.

The factors which hold the largestimpact on the chosen structure arethe fund's investment program andthe types of investors who will investin the fund.

The fund manager will seek to utilizeentities domiciled in jurisdictionswhich have clear and predictablelaws, quality service providers, andare familiar to investors.


How are Hedge Funds Structured?
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The main categories of investors are:

Taxable U.S. investors (e.g., individuals and family partnerships) Tax-exempt U.S. investors (e.g., pension funds, foundations and

endowments) Non-U.S. investors. (e.g., individuals and institutions)

In order to address the concerns of each of the foregoing typesof investor, a fund manager generally will offer both a U.S.vehicle and an offshore (non-U.S.) vehicle.

This presentation focuses on the structure of offshore vehiclesand the general business and regulatory environment inpopular offshore jurisdictions, such as the Cayman Islands, theBritish Virgin Islands, Bermuda, and Ireland.

U.S. - Domiciled

Vehicle

Offshore Vehicle


Categories of Investors


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*Based on Institutional CapitalSource: Preqin Special Report: Hedge Funds, October 2012.

A majority of hedge fund investors are tax-exempt institutional investors.


Hedge Fund Investor Composition*


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Countries such as the Cayman Islands, Bermuda, Ireland, and the British Virgin Islandsare popular choices for setting up offshore hedge funds because they:

Charge no, or low, entity-level taxation.

Have a robust regulatory regime, including anti-money laundering measures and bankregulations.

Have a developed financial industry that can supply qualified service providers(licensed by local governmental authorities) to serve as legal counsel, administrators,auditors and directors of hedge funds.

Many of these jurisdictions operate as British Overseas Territories and utilize a commonlaw legal system which provides a familiar foundation in entity and contractual law thatmakes them attractive jurisdictions for investors looking to invest abroad .

Offshore Jurisdictions Why Do Hedge Funds Set Up Entities in the CaymanIslands?


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Source: Preqin Special Report: Hedge Funds, October 2012.

Breakdown of Hedge Fund Domiciles


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Because U.S. corporations are subject to income tax on investment income as well asbusiness income, tax-exempt U.S. investors prefer to invest in non-U.S. corporations, whichare not subject to income tax in the jurisdiction in which they reside and which generally canavail themselves of a safe harbor from U.S. taxation if they receive only investment and

trading income.

A non-U.S. corporation, however, is subject to U.S. withholding tax on U.S. dividends andcertain other types of U.S. source income.

Tax-exempt U.S. investors do not pay U.S. tax on unleveraged investments in dividend-paying stocks owned through a flow-through entity.

Addressing the Concerns of Tax-Exempt U.S. Investors


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Non-U.S. Investors Generally Do Not Want to Incur U.S. Taxes

Non-U.S. investors include foreign natural persons and a variety of foreign entities.

Non-U.S. investors generally prefer not to be U.S. taxpayers or to file U.S. tax returns withrespect to their investment activities, which generally would be the case if they invested in aU.S. entity or an entity which was a pass -through entity for U.S. tax purposes.

Similar to tax-exempt U.S. investors, non-U.S. investors generally prefer to invest in non-U.S. corporations because the corporate entity is the U.S. taxpayer and tax filer and canoften benefit from the safe harbor from U.S. taxation (other than withholding taxes) if it

receives only investment trading income.

Non-U.S. Investors


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There are a number of structural approaches employed by hedge funds to accommodatedifferent investors. Three basic structures a stand-alone structure, a side-by-sideinvestment structure and a master-feeder structure are outlined below.

Hedge Fund Investment Structures:

Stand-Alone Side-by-Side Master-Feeder

How does a hedge fund accommodate the interests of different investors at thesame time?


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In its most basic form, a hedge fund is a single entity, to whichthe investors contribute funds.

As a result of the considerations outlined above, a stand-alonestructure is limited in the types of investors it can efficientlyaccommodate.

General PartnerLLC

DomesticHedge Fund LP Investment Manager LP

TaxableU.S.

Investors

Investments

General Partner ofInvestment Manager

LLC

Stand Alone Structure


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The side-by-side structure is a two-fund structure which includes a U.S. fund (e.g., aDelaware limited partnership) and an offshore fund (e.g., a Cayman Islands exemptedcompany).

A side-by-side structure is often formed in order to address the concerns of each typeof domestic and offshore investor.

The fund manager advises each fund in the side-by-side structure, and each fundmakes the same, or substantially the same, investments.

Side-by-Side Structure


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DomesticHedge Fund LP

Non-U.S. &Tax-Exempt

U.S. Investors

Investments

General PartnerLLC


LLC

Investment Manager LP

Taxable U.S.Investors Offshore

Hedge Fund Ltd .

Investments

Side-by-Side Structure


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An advantage of the side-by-side structure is that, due to the segregation of taxable andtax-exempt U.S. investors into separate fund entities, tax and regulatory sensitivities(e.g., long-term capital gains holding periods) can be managed for a specific type ofinvestor.

A drawback to the side-by-side structure is that it requires the fund manager to placeseparate orders for each fund (often at higher overall cost), and often portfolios arerebalanced between funds (e.g., when a funds size changes due to subscriptions andredemptions).

Administrative and audit costs may also be higher due to maintaining two portfolios.

Advantages and Disadvantages of a Side-by-Side Structure


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In a master-feeder structure, like a side-by-side structure, a domestic fund and anoffshore fund are established.

However, rather than each fund directly holding a portfolio of investments, each fund(known as a feeder fund) invests indirectly in a single portfolio through a masterfund.

The master fund is a pass-through entity for U.S. tax purposes, which preserves thetax character of investments for taxable U.S. investors.

As a result, the fund manager makes a single investment decision which is thenapportioned to the fund feeders, and then makes its way back to the variousinvestors. The feeder funds participate indirectly in the master funds portfoliothrough their ownership of the master fund.

Master-Feeder Structure


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A master-feeder structure tends to be efficient and cost effective from a portfolio andoperational perspective.

However, the master-feeder structure can present conflicts of interest in cases wherean investment may be tax-efficient only for either the domestic feeder fund investorsor the offshore feeder fund investors. This can be addressed by having each feederfund maintain the discretion to make direct investments, although it is rarely practicalto do so.



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General PartnerLLC

DomesticHedge Fund LP

Taxable U.S.Investors

Non-U.S. &Tax-Exempt

U.S. Investors

OffshoreHedge Fund Ltd.

Investment Manager LP


LLC

Investments

MasterFund (Ltd./LP)



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Acknowledgements

MFA would like to acknowledge Schulte Roth & ZabelLLP (www.srz.com) for their advice and counselthroughout the drafting process of this presentation. SRZis a full-service law firm with offices in New York,Washington, D.C. and London. As one of the leading lawfirms serving the alternative investment industry, the firmregularly advises clients on corporate and transactionalmatters, as well as providing counsel on securitiesregulatory compliance, enforcement and investigativeissues.

Hedge Fund Structre

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