Foundation — The fee structure, hurdle, high-water mark and catch-up

Think of it like this

Key terms in this chapter

Absolute-return Strategy

A strategy aiming to make returns independent of broad market movements, benchmarked against a fixed pre-determined rate such as 10 per cent per annum rather than a market index.

Alpha

The excess return generated by a Category III AIF over the benchmark return for the same period, computed as the actual return less the CAPM expected return.

Base Expense Ratio (BER)

The AMC-controlled portion of a mutual fund's TER, subject to a mandatory upper cap that effectively restricts a mutual fund manager's income to approximately 1.5 per cent, against up to 2.5 per cent for a Category III AIF.

Benchmark

The comparable fund or index having similar risk-return characteristics to the fund being monitored. A valid benchmark is specified in advance, relevant, measurable, unambiguous, representative, accountable, investable and complete.

Benchmarking Agency

An agency notified by an AIF association representing at least 33 per cent of AIFs, which collects performance, cash-flow and valuation data and creates industry benchmarks. IVCA has appointed CRISIL, NSE and Preqin.

Benchmark Report

The standard report generated on SEBI's mandate by a benchmarking agency, as distinct from a customised, fee-based Performance Report prepared at an AIF's specific request with the express consent of the AIFs whose data is used.

CAGR

Compounded Annual Growth Rate — the ending value divided by the beginning value, raised to the power of one over the number of years, minus one. It expresses growth after accounting for compounding.

Catch-up Rate

The rate at which residual profits after returning capital and hurdle flow to the manager until he reaches his pre-determined share of total profits. In the XYZ Fund example a 100 per cent catch-up gave the manager Rs 3.45 crore against Rs 0.69 crore with no catch-up.

Composite

Under GIPS, a grouping in which an AIF reports consolidated performance of its schemes, defined by the investment strategy or investment objective those schemes follow.

DPI

Distributions to Paid-in Capital — total distributions divided by total capital contributions, measuring the amount distributed per rupee invested. Also called the realisation multiple.

Excess Kurtosis

Kurtosis minus three. A positive value indicates fatter tails and higher risk; a negative value indicates consistent frequencies around the mean.

GIPS

Global Investment Performance Standards — the global standard for calculating and presenting investment performance, requiring composites, prescribed methodologies, and annual performance for a minimum of five years building to ten.

Gross IRR

IRR computed on fund-level cash flows before deducting management fees, incentive fees, fund expenses and taxes paid.

Gross Net Asset Value (GNAV)

The value on which management fees are computed, before deduction of fund liabilities and expenses. Management fees are not charged on committed capital or capital contributions.

High-Water Mark

The highest net asset value, net of operating expenses, transaction expenses and management fees, achieved by the fund at the end of any year. If NAV has only decreased since inception, it is the initial subscription price of units.

Hurdle Rate

The minimum rate of return to be accrued to fund investors each year or shorter period, generating the preferred return. Managers prefer it low and investors prefer it high; Indian rates run 10 to 12 per cent against international 7 to 8 per cent.

Incentive Fees

Also called performance fees — a percentage of the incremental return earned by the fund, generally between 0 and 20 per cent, computed as per the PPM and, for closed-ended funds, payable after completion of the stated fund tenure.

Kurtosis

The degree to which a distribution is more or less peaked than a normal distribution, which has a kurtosis of three. Above three is leptokurtic and riskier; below three is platykurtic.

Management Fees

The fee paid to the manager for fund management services, charged as a fixed percentage of Gross NAV ranging from 1 to 2.5 per cent, accruing from first close to dissolution, generally paid in arrears within 14 days of the valuation day, and payable irrespective of gains or losses.

Market Risk Premium

The excess return of the benchmark or broad-based index over the risk-free rate, the term multiplied by beta in the CAPM expected return formula.

Maximum Drawdown

The peak-to-trough decline in a fund's AUM over a reporting period, quoted as a percentage of the peak. It does not show how often large losses occur or how long recovery takes.

Minimum NAV Eligible for Incentives

The higher of the reference hurdle and the high-water mark. Incentive fees are earned only on the amount by which NAV before incentives exceeds this figure, and not at all if the difference is negative.

MOIC

Multiple on Invested Capital — total realised and unrealised returns divided by total invested capital. Once all capital calls are met it equals TVPI, and a consistently large MOIC to RVPI ratio is a red flag on valuations.

Net IRR

IRR computed on investor-level cash flows, treating fund expenses, management fees and incentive fees as investor outflows and distributions after tax as inflows. It is always lower than gross IRR.

Over-commitment Strategy

The practice by which institutional investors let forecast capital calls on outstanding commitments exceed current cash balances, to avoid diluting returns by holding idle cash against uncertain calls.

Performance Fees Crystallization Date

The concept under which performance fees accrue daily so that reported returns are accurate, while actual payment to the manager happens only at the end of the fund term.

PIC Multiple

Paid-in capital divided by capital commitments, measuring how invested the fund is. A high PIC means the fund is near the end of its drawdown phase.

Preferred Return

The portion of total fund return generated by the hurdle rate that accrues to investors only, allocated pro-rata. It is not taken into account directly when computing incentive fees, which are paid only on returns above it.

Reference Hurdle

The absolute amount computed by applying the hurdle rate to the called-up capital at the beginning of the year, against which the NAV before incentives is compared.

Risk of Adverse Selection

The investor-level risk of choosing the wrong fund manager, since PPMs may make forward-looking statements or show track records that do not assure future performance, leading to sub-optimal returns or moral hazard.

RVPI

Residual Value to Paid-in Capital — assets under management divided by total capital contributions, representing the unrealised value still at market risk.

Set-up Costs

One-time organizational expenses charged as a percentage of total capital commitments, up to 1.5 or 2 per cent, covering offering costs, PPM drafting, registration and compliance, and intermediary commissions, amortisable over the first 36 months or the entire fund life from first closing.

Sharpe Ratio

Expected portfolio return less the risk-free return, divided by portfolio standard deviation — the excess return per unit of total risk. Ratios greater than one are preferable, and it is preferred over Treynor for undiversified portfolios.

Since-inception IRR

IRR calculated on all cash flows from the launch date of the fund to the reporting date. Where computed for a fund already liquidated, it is also called life-time IRR.

Skewness

The extent to which a distribution is not symmetrical across the mean, arising from outliers. A normal distribution has skewness of zero; positive skew puts the mean above the mode with a long right tail, negative skew puts the mean below the mode with a long left tail.

Standard Deviation

The square root of the average squared deviation of returns from the mean, measuring the volatility of returns and hence the historical risk of the fund.

Total Expense Ratio (TER)

The mutual fund measure representing the total cost borne by investors, effective from 1 April 2026, consisting of the Base Expense Ratio and external charges including brokerage, exchange and regulatory fees and statutory levies.

Transaction Expenses

Brokerage, depository charges, custodian transaction charges, securities transaction taxes and exchange charges, borne by the fund and allocated pro-rata across all classes of units based on capital contributions or NAV.

Treynor Ratio

Expected portfolio return less the risk-free return, divided by portfolio beta — the excess return per unit of systematic, non-diversifiable risk.

TVPI

Total Value to Paid-in Capital — cumulative distributions plus residual value divided by paid-in capital, equal to DPI plus RVPI. Commonly called the net multiple; it fluctuates until the fund is fully realised.

Value at Risk (VaR)

The maximum expected loss over a given time frame at a pre-defined confidence level. It quantifies the maximum potential loss but fails to indicate the size of losses beyond that confidence level.