Fund Governance
The control structure within which an AIF is managed, directed and controlled — manager oversight, independent valuation, segregation of functions, conflict management, transparency and an investor-first culture.
In plain language
An AIF takes big bets on a few companies with investors' money. The risk is tied to those companies (unsystematic risk). The money stays in for years, in assets that are hard to sell. If the people running the fund are careless or dishonest, investors cannot just walk out. That is why the workbook calls fund governance "an important question to address".
Its definition is short. "At its simplest, fund governance means the control structure within which funds are managed, directed and controlled."
It has five main themes. The first two are manager oversight and outsourced independent valuation. The third is segregation of functions, which means keeping key jobs apart. The last two are absence of conflicts of interest and increased transparency and reporting.
Governance reaches beyond the manager. It takes in key service providers: custodians, prime brokers, administrators, investment advisers and distributors. Investors may also fairly count the regulator where the fund is based as part of it.
Rules and structures are not enough on their own. Good governance also needs the right culture in the fund, the manager and the other service providers. In that culture, "investors' interests are of primary importance".
How it works
Why it matters now. The workbook points to high-profile fund failures from fraudulent manager activity in developed countries (Madoff, Weavering, Petters, LTCM), investor legal action against managers (Medley), increased regulatory activity and volatile markets — while institutional investors, family offices and HNIs have become the primary source of AIF money.
The regulatory anchor. Regulation 21: the sponsor and manager "shall act in a fiduciary capacity towards its investors and shall disclose to the investors, all conflicts of interests as and when they arise or seem likely to arise", with written policies to identify, monitor and mitigate conflicts.
The structure in a trust-based AIF (section 7.6.2) centres on three parties: the AIF trust, the investment management company and the trustee.
- The manager's obligations: address all investor complaints; provide SEBI any information sought; maintain records as specified; take all steps to address conflicts of interest; ensure transparency and disclosure.
- Compliance Test Report: filed by the manager at the end of every financial year and submitted to the sponsor (and trustee if a trust) within 30 days of year end; observations back to the manager within 30 days of receipt; manager's changes and reply within 15 days; any violation intimated to SEBI as soon as possible.
- Board of the AMC: overall supervision of the investment management function; the trustee handles trust administration. Their roles are spelt out in the trust deed and the investment management agreement.
- Investment Committee (optional) approves decisions; Investor Advisory Committee (optional) advises.
- Conflicts: code of conduct, disclosure, written policies; the stewardship circular adds blanket bans, a conflict of interest committee, segregation of voting from sales, recusal policies and minutes.
- Grievances: SCORES; AIFs redress grievances within 21 calendar days; online dispute resolution available.
Stewardship. Fund governance "also includes high quality engagement with the investee companies". SEBI has mandated stewardship responsibilities for AIFs' investments in listed companies, under six principles: a stewardship policy; a conflict of interest policy; monitoring investee companies; an intervention policy; a voting policy with disclosure; and periodic reporting.
An oversight board with sufficient independence, commitment and knowledge can help ensure an appropriate control structure and a culture that prioritises investors.
A worked example
Illustrative figures. A family office is choosing between two Category II AIFs, each targeting Rs 800 crore, and its adviser runs a governance check.
| Governance point | Fund A | Fund B |
|---|---|---|
| Valuation | Independent valuer, half-yearly | Internal team values; independent valuer "being considered" |
| Investment Committee | Two external independent members named in PPM | Only the manager's partners |
| Investor Advisory Committee | Five seats, majority investors | None |
| Service providers | Custodian and fund accountant unrelated to the sponsor | Fund accountant is a sponsor group company |
| Compliance Test Report | Submitted to trustee on 28 April; trustee observations on 20 May; reply on 30 May | Submitted to trustee in September |
| Stewardship policy | Published on website, voting record disclosed | Not published |
Fund B's CTR in September is well outside the 30 days after a 31 March year end. Its valuation is not outsourced to an independent valuer — one of the central themes of fund governance, and the half-yearly independent valuation of Category I and II AIF investments is a regulatory requirement. Its fund accountant being a sponsor group company is a segregation and conflict problem.
None of that says Fund B will perform worse. It says the family office would have far less protection if it did. The adviser recommends Fund A.
Why NISM asks about it
Chapter 7 (Investment Process and Governance of Funds) sets out the role of fund governance at 7.6.1 — including SEBI's stewardship principles — and the governance structure at 7.6.2 through 7.6.2.5: the Investment Committee, the Investor Advisory Committee, the board of the AMC, conflicts of interest and grievance redressal. Chapter 8 (Fund Due Diligence) asks investors to examine the fund governance structure and policies, and Chapter 10 (Fund Monitoring, Reporting and Exit) treats monitoring as oversight of fund governance. Expect questions on the definition, the central themes, the Compliance Test Report timelines and the six stewardship principles.
Common exam traps
- Fund governance is wider than the manager. Service providers, and in the investor's view even the regulator, are part of the framework.
- Structures are not enough; culture matters — the workbook says so explicitly.
- Compliance Test Report timelines: 30 days, 30 days, 15 days. Manager to sponsor/trustee within 30 days of year end; observations within 30 days of receipt; changes and reply within 15 days.
- Grievances are redressed within 21 calendar days under the SCORES framework.
- Stewardship responsibilities apply to AIFs' investments in listed companies, and there are six principles.
- Fund monitoring is not fund management. Investors monitor governance and performance; they do not take investment decisions.
- Fund governance is not corporate governance of the investee company, though high-quality engagement with investee companies is part of it.
Where this is taught
Free preparation for NISM Series XIX-ARelated terms
- Conflict of interestAny interest of the analyst's own — a shareholding, a fee, a relationship — that could bias the research, and which the regulations require to be disclosed rather than merely avoided.
- SCORESSEBI's centralised web-based system for processing investor complaints, on which the company or intermediary must upload an Action Taken Report and the investor can watch the status online.
- Code of conductThe conduct obligations a broker accepts as a condition of registration — integrity, due skill and care, no manipulation, and a specific list of duties owed to the client and to other brokers.
- Stewardship codeSEBI's mandatory code requiring all AIFs and mutual funds to monitor, engage with and vote in the listed companies they invest in — and to publish the policies by which they do it.
- Compliance Test ReportThe annual self-certification an AIF manager prepares in SEBI's prescribed format, testing the fund against the AIF Regulations and routed through the sponsor and trustee for comment.
- Investment CommitteeA committee the manager of a Category I or II AIF may constitute to approve the fund's investment decisions; its members are responsible for those decisions and bound by the Code of Conduct.
- Investor Advisory CommitteeAn optional committee of mainly investor representatives that gives an AIF's manager or Investment Committee informed guidance on conflicts, risk, governance, reporting and tax — a check, not a decision-maker.
- Leveraged Buy-OutA control acquisition of a company financed substantially with borrowed money — a Private Equity buyout where the acquirer typically targets 51% or more of the target's share capital or voting rights.
- Realisation RiskThe risk that the environment for exiting an investment changes for the worse before the fund is ready to sell — one of the specific risk categories SEBI requires an AIF to report on at fund and investee company level.
- Super CarryAdditional return (carry) charged by a highly sought-after AIF manager above the industry-norm "2 and 20" benchmark, reflecting strong negotiating power from a high performance track record.