Management Fee

The management fee is what the manager is paid for turning up. It is not a share of profit, it is not contingent on the fund making money, and it is payable in a year in which every portfolio company loses value.

That is deliberate. The fee funds the team, the research, the deal sourcing and the compliance function — costs that exist whether or not the vintage works out. Profit-sharing is a separate payment with a separate name: incentive fee, performance fee, or carried interest.

What varies, and what the exam tests, is the base the percentage is applied to. It is not the same base in every category, and it changes part-way through a Category I or II fund's life.

Category III AIFs charge a fixed percentage — the workbook gives a range of 1% to 2.5% — of the fund's Gross Net Asset Value. GNAV is the gross value of the underlying investments plus liquid balances, after deducting outside liabilities as of that date but before accounting for management fee and incentives. Fees are generally paid in arrears, monthly or quarterly, when GNAV is computed.

Category I and II AIFs charge on committed capital during the commitment period. Afterwards the base may step down to actual invested capital, where that is lower, or to the underlying value of assets under management. Investors typically push for the post-commitment fee to be charged on the original amount of invested capital rather than on amounts consumed by expenses and fees. As the Indian market has scaled, managers have been moving the fixed fee down into a 1% to 1.75% band.

Two timing rules matter. The fee accrues from the date of first close and runs until the AIF is dissolved. And the fee may differ by the size and timing of an investor's commitment — those differences are expressed as different classes of units, not as side deals.

GST at 18% applies to management fees and trusteeship fees, and to the services of custodians, administrators, auditors, legal advisers and investment advisers. It is a real cost to the fund and it is examinable.

The management fee is not the whole cost. Sitting alongside it:

The negotiation an investor should be having is about the cap on avoidable expenses, and ideally about netting third-party fees off against the management fee already being paid.

Fund ABC launches on 1 January 2019 with Rs 50 crore of total capital commitment and a management fee of 1.5% excluding GST. Gross NAV reaches Rs 58 crore at the end of year 1 and Rs 65 crore at the end of year 2.

Scenario A — structured as a Category I AIF, fee on total capital commitments:

Scenario B — structured as a Category III AIF, fee on gross NAV:

Same manager, same 1.5%, same fund — Rs 26.55 lakh more over two years in Scenario B, because the base grew with the portfolio while committed capital did not.

Now add the other layers to Scenario A. Set-up costs at 2% of Rs 50 crore are Rs 1 crore, amortised over 36 months at roughly Rs 33 lakh a year. Operating expenses capped at 50 basis points of commitments are Rs 25 lakh. Trusteeship fees are Rs 3 lakh. Before a single transaction cost, the annual charge is:

Management fee incl. GST      Rs 88.50 lakh
Amortised set-up cost         Rs 33.33 lakh
Operating expenses (cap)      Rs 25.00 lakh
Trusteeship fee               Rs  3.00 lakh
                              ─────────────
Total                         Rs 149.83 lakh  =  3.00% of committed capital

The headline is 1.5%. The load in the early years is twice that.

Chapter 9 (Fee Structure and Fund Performance), section 9.1 is the whole of this — the fee bases by category, the GNAV definition, set-up costs, operating expenses, transaction expenses and trusteeship fees. The chapter runs worked computations of exactly the kind above, and Chapter 9 also supplies the GST illustration. Expect at least one calculation asking for the fee and the GST on it, and a conceptual question on which base applies to which category.

• Category I and II charge on committed capital; Category III charges on gross NAV. Reversing them is the single commonest error, and both appear in the same question as two scenarios.
• GNAV is struck before management fee and incentives but after outside liabilities. Computing the fee on a NAV that has already had the fee deducted gives a circular, wrong answer.
• The fee accrues from first close, not from SEBI registration and not from the first investment.
• GST at 18% is on top of the fee, not inside it. A question that gives you a fee "excluding GST" is telling you to add it.
• Management fee is not the incentive fee. It is paid irrespective of gains or losses; incentive fee is paid only on incremental return above the hurdle, and for closed-ended Category III AIFs usually only at the end of the fund term.
• Transaction expenses have no cap. Operating expenses do (10 to 50 basis points); set-up costs do (up to 1.5% or 2.5% of commitments). Do not apply a cap to the uncapped bucket.
• Different fee terms live in different classes of units. They are not informal discounts.