The Separation of Funds and Managers: A Theory of Investment Fund Structure and Regulation

This Article offers a broad theory of what distinguishes investment funds from ordinary companies, with ramifications for how these funds are understood and regulated. The central claim is that investment funds (i.e., mutual funds, hedge funds, private equity funds and their cousins) are distinguished not by the assets they hold, but by their unique organizational structures. These structures separate investment assets and management assets into different entities with different owners. The investments belong to “funds,” while the management assets belong to “management companies.” This structure benefits investors in the funds in a rather paradoxical way: it limits their rights to control their managers and share in their managers’ profits and liabilities. Fund investors accept these limits because certain features common to most investment funds make them efficient. Those features include powerful investor exit rights and economies of scope and scale that encourage managers to operate multiple funds at the same time. These features diminish the importance of control and increase the importance of asset partitioning. This way of understanding investment funds sheds light on a number of key areas of contracting and regulation and refutes the claims of skeptics who say that fund investors would be better off if they employed their managers directly.