Target Return

Ask a fund manager what the fund will make and you get a number. That number is the target return.

It is not a promise. Nothing happens to the manager if the fund misses it. The workbook's reason for caring about it is narrower and more useful than a forecast: the target return tells the investor how much risk the manager plans to take to get there.

Read it that way and it becomes a due diligence tool. A manager targeting a very high return is telling you what kind of deals it will do and what kind of companies it will back. A modest target says the opposite.

It is easy to mix up with the hurdle rate. The hurdle rate is a real contract term and decides when the manager starts earning its share of the profit. The target return decides nothing. It is a pitch.

And a distributor has to be careful with it. Presenting a target as something the investor will get is not allowed.

The definition, from section 8.5. Under the heading Hurdle rate / target returns, the workbook says the fund manager may mention a target return that they intend to achieve from a prospective scheme or fund, and that this would provide enough guidance to investors as to the level of risk taking being proposed by the manager. That is the whole of it — a voluntary disclosure whose value is as a risk signal.

Where an investor asks for it. Annexure 8.1's due diligence questionnaire puts it under Proposed Fund / Scheme Details, in a cluster that shows the company it keeps:

• Target size of the fund, and whether there is a green shoe option
• Tenure of the fund, and extension
• Plans for first and final closing
• Sponsor and sponsor commitment
• Target returns — hurdle rate, intended returns

So in the workbook's own phrasing, target returns has two components: the hurdle rate, which is contractual, and intended returns, which are not.

Against what the target is judged. Not against itself. Chapter 8 measures delivery by fund level FIRR both gross and net (after all fees, expenses and carry) and investor level FIRR (after fee and carry), and then against the industry benchmark under performance benchmarking. A target return that is never checked against a benchmark report is a marketing line.

The figure the workbook does NOT give. There is no numeric target return anywhere in XIX-A. What the paper does give, in the very same bullet, is the calibration of the hurdle rate — a different number doing a different job:

Do not attach any of those three figures to a target return. They calibrate the hurdle.

And the hard rule for the distributor. Chapter 13's good practices require a distributor to abstain from indicating or assuring returns in AIF schemes unless it is a pure debt scheme with assured returns as explicitly provided in the PPM. A manager may state a target in its own fund documents; a distributor may not turn that target into an indication of what the client will receive.

Kalindi Mid-Market Fund II, a Category II AIF. Illustrative figures.

The pitch, as the manager frames it:

Seven years later, the fund has drawn down Rs 400 crore and distributed Rs 700 crore, for a net FIRR of 11.5%.

Target return   22%    missed by a very wide margin
Hurdle rate     12%    net FIRR of 11.5% is BELOW it
  -> no additional return to the manager at all
  -> and no breach of contract, because 22% was never promised

The investors have no claim for the shortfall against the target. What they do get is the answer to the question the target was actually asking: a manager who said 22% and delivered 11.5% either mis-read its own risk or took risk it could not convert.

Now change one number. Suppose the net FIRR had been 13%.

Above the 12% hurdle, so carry is earned on the excess
Still nowhere near the 22% target

The manager is paid its additional return on a fund that missed its own stated ambition by 9 points. That is exactly why Chapter 8 says a hurdle set too low lets a manager get a higher share of additional return, and why an investor tests the hurdle and the target against each other rather than reading either alone.

And if Kalindi's distributor had told a client to expect 22%, it would have breached the good-practice rule against indicating or assuring returns — which is not a pure debt scheme with assured returns set out in the PPM.

Chapter 8 (Fund Due Diligence — Investor Perspective), section 8.5 on the broad aspects of fund due diligence, where target returns share a bullet with the hurdle rate, and Annexure 8.1, where the questionnaire asks for them under Proposed Fund / Scheme Details. Chapter 13 (Good Practices) supplies the distributor's limit. Chapter 3 (Concepts in Alternative Investment Funds Industry), section 3.8, gives the hurdle-rate background.

The question that comes up is the distinction question: which of hurdle rate and target return is contractual, and which merely signals the manager's risk appetite. Chapter 13's sample question is the other reliable one — one of the distributor good practices is to identify funds that provide minimum guaranteed return that meets the hurdle rate of the investor: true or false? The answer is false, and target returns are the reason candidates get it wrong.

• Target return is not the hurdle rate. The hurdle is in the fund documents and gates the manager's carried interest. The target is an intention with no consequence. A fund can miss its target and still pay full carry, as the worked example shows.
• It is not a guaranteed or assured return. Chapter 3 says the hurdle rate exists to benchmark the expectations of the investors rather than to provide a guaranteed return, which is neither permissible nor possible, and a target return is weaker still.
• XIX-A gives no number for a target return. The 8-10%, 15% and 25% figures in section 8.5 calibrate the hurdle rate, not the target.
• The workbook's own Indian hurdle figures do not agree with each other, and both are examinable. Section 3.8 says Indian VC and PE hurdle rates could therefore be around 10% to 12%, above an international norm of around 8%, with historical Indian stock market returns estimated around 15%. Section 8.5 instead calls 8 to 10% too low and puts a reasonable Indian hurdle at say 15%. Two chapters, two answers. Answer from whichever chapter the question is drawn from and do not average them.
• A manager may state a target; a distributor may not indicate or assure returns. The one exception in Chapter 13 is a pure debt scheme with assured returns explicitly provided in the PPM.
• Target size and target return are different rows of the same questionnaire. Target size is the corpus the manager is trying to raise, and it is the one with the green shoe option attached.