Key-Person Risk

Investors in a Category III AIF are rarely buying a strategy in the abstract. They are buying a particular manager's judgement. That is the fund's strength, and it is also a single point of failure.

The workbook describes the investment managers as the key persons for the fund: they make all the investment decisions, fulfil redemption requests, ensure compliance and see to seamless trade execution. Any adverse event — death, insanity, incapacity or immovability of the investment manager — can significantly hamper the fund's operations and threaten the net return investors earn.

The risk is sharpest where the fund relies on a single investment manager. The due diligence question is therefore not just "is the manager good?" but "what happens here if the manager is gone?"

The workbook places key-person risk at several points in a fund's life.

In the PPM. Among the matters the PPM covers is the identification of Key Persons in the Fund, without whom the Fund may be meaningless to operate.

In investor due diligence (Chapter 7):

• Manager selection — the manager is a key person, so investors should check the manager was appointed through a proper screening and selection process. An informal appointment may indicate a fund privately run by sponsor and manager without aligning investors' interests.
• Key-person risk — investors, directly or through consultants, should hold on-site meetings with the manager and the whole team for investment management, trade execution, research and compliance, to see whether the fund depends on the manager alone.
• Business continuity and disaster recovery — continuity can be affected by material key-person events or natural disasters, so the fund needs adequate plans.

Through insurance (Chapter 10). Key-man insurance compensates the fund for financial losses from the death, incapacity, kidnap or disability of a key executive. It gives comfort that the fund can make an orderly dissolution or transition to a new manager under succession planning. The premium is indirectly borne by investors, and the amount of insurance taken is typically around 1–2% of total assets under management.

Team qualifications. At least one person in the manager's key investment team must hold the NISM Series XIX-C or XIX-E certification, and at least one must hold a specified professional qualification; one person may satisfy both.

Illustrative figures. Kaveri Special Situations Fund manages Rs 400 crore. Its returns rest almost entirely on its founder-manager, Mr Arvind Menon.

Due diligence by a pension fund:

If the fund bought cover at the workbook's typical level:

1% × Rs 400 crore = Rs 4 crore
2% × Rs 400 crore = Rs 8 crore

That cover — its premium ultimately paid by investors — is meant to fund an orderly exit or a handover to a successor manager. It does not replace judgement. The pension fund's conclusion: the strategy is attractive, but the fund is effectively a one-person operation, and it asks for a named second key person and a succession plan before committing.

Chapter 7 (Investment Strategies and Due Diligence Process) lists key-person risk as a separate due diligence point and returns to it under manager selection and business continuity. Chapter 10 (Good Practices) covers key-man insurance and its typical size. Chapter 5 carries the PPM content requirement to identify key persons and the certification requirement for the key investment team. Expect questions on the events that trigger the risk, on-site meetings as the test, and the 1–2% of AUM figure.

• The key person is the investment manager, not a large investor or the trustee.
• The test is dependence on one person — hence on-site meetings with the entire team, not only the manager.
• Key-man insurance cover is typically 1–2% of AUM; that is the amount of insurance, not the premium.
• The premium is borne indirectly by investors, even though the fund buys the policy.
• Key-man insurance covers death, incapacity, kidnap or disability. Do not mix it up with D&O liability insurance, which the workbook says does not cover fraudulent acts of directors and officers.
• Material key-person events are a business continuity issue, so a continuity plan silent on them is a gap.
• Do not confuse this with the equity-research sense of the same words. Series XV teaches keyman risk as a company depending too heavily on one or two individuals — a risk inside a business you might invest in. Here the person is the fund's own investment manager, and what breaks is the fund.