Hedge Fund Business Models

A hedge fund has many creditors. Broker-dealers are liable on unset-
tled trades. Financing counterparties generally have collateral to secure
their lending, but rapid changes in asset values can leave secured lenders
exposed to default. Derivatives counterparties also margin their exposure
to hedge fund default, but the margin may be inadequate. If a hedge fund
fails, the losses cascade beyond the hedge fund investors.
When a hedge fund has investors from many different countries, it is
usually efficient to organize the fund in a low-tax or no-tax domicile. This
is a tax avoidance strategy but it is not a tax evasion strategy. The differ-
ence is important. By structuring a hedge fund offshore, a French investor
avoids paying taxes to the United States but does not avoid paying taxes to
the French government.
Figure 5.8 shows a simple structure for an offshore hedge fund. In
this master-feeder structure, a corporation is created in a low-tax or no-
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HEDGE FUND COURSE
FIGURE 5.8
Offshore Hedge Fund Structure
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