Operating Expenses

An AIF investor pays for the fund in layers. There is the management fee that goes to the manager, the one-time set-up cost of launching the fund, transaction expenses each time something is bought or sold — and the operating expenses of keeping the fund running year after year.

Operating expenses are the auditors, lawyers, tax advisers, custodians, fund administrators, investor reports, insurance and statutory filings. They are charged to the fund, which means every investor bears them pro rata.

Because they come out of investors' returns whether or not the fund makes money, investors usually insist on caps — per head of expense, or for the total over the fund's life or each year. The workbook's description: typically subject to some limit like 10–50 basis points charged on the NAV or the capital commitments, whichever is higher, and the limit is yearly.

What is inside (section 7.1). The workbook's list includes:

• statutory, legal, tax, accounting, audit and consulting fees;
• banking, broken-deal, registration and finders' fees;
• expenses of investor meetings (but investors' own travel is borne by them);
• the cost of collecting capital contributions;
• interest on borrowings, if any — applicable for Category III AIFs;
• financial statements and investor reports, record-keeping;
• fees to banks, merchant banks and consultants serving the fund;
• reasonable insurance premiums for directors, partners and key personnel of the trustee and manager;
• taxes and costs of acquiring, holding and selling assets;
• proportionate liquidation expenses.

What is not. Section 5.1.10.2 is clear that the cost of the investment management function — rent, office maintenance, travel, deal due diligence, transaction documentation — must be borne by the manager and cannot be charged to the fund. That is what the management fee is for.

How it sits beside the other layers:

The workbook advises investors to negotiate caps on avoidable expenses — and, best case, to net them off against the management fee already paid.

Fund size and the chosen cap are illustrative; the 10–50 bps range, "whichever is higher" and the set-up and trusteeship ranges are the workbook's.

A Category III AIF has capital commitments of Rs 200 crore and a current NAV of Rs 180 crore. The PPM caps operating expenses at 30 basis points a year, on NAV or commitments, whichever is higher.

30 bps × Rs 180 crore (NAV)          = Rs 54 lakh
30 bps × Rs 200 crore (commitments)  = Rs 60 lakh
Annual cap (the higher)              = Rs 60 lakh

The fund's actual bills for the year:

The total is Rs 2 lakh over the cap, which is exactly the kind of breach the investor negotiated the cap to catch; how the excess is dealt with is whatever the PPM provides.

For comparison, the one-time set-up cost at 1.5% of commitments would be Rs 3 crore, and brokerage and STT on trades are transaction expenses with no cap at all. An investor who reads only the operating-expense cap has read one layer of four.

Chapter 7, section 7.1 (Management Fees and Other Expenses), gives the definition, the 10–50 bps illustration and the full list; section 5.1.10.3 in Chapter 5 introduces set-up costs and operational expenses side by side. Example 7.10 then runs Rs 30 lakh of yearly fund expenses through a gross-to-net IRR calculation. Expect a "which of these is an operating expense / transaction expense / set-up cost" question, and one on whose cost the manager's own office and deal expenses are.

• Operating expenses are capped; transaction expenses are not. The workbook says transaction expenses are borne on actual basis, "without any limits".
• The illustrative cap is on NAV or commitments, whichever is higher — not whichever is lower.
• The limit is yearly.
• Interest on borrowings appears in the list for Category III AIFs, because they may borrow.
• The manager's own office rent, travel and deal due diligence are not fund expenses. They come out of the management fee.
• Set-up costs are one-time; operating expenses recur. Do not add them together as if both were annual.
• Net IRR is lower than gross IRR partly because of operating expenses — they are a real drag on investor returns, not a rounding item.