NISM Series XIX-E · Chapter 7: Fee Structure and Fund Performance

L1 · Foundation

What an AIF Costs and What Can Go Wrong

Every fee and expense a Category III AIF charges, how the hurdle rate, high-water mark and catch-up decide what the manager earns, why gross and net returns differ, the GST drag, and the investor-level, fund-level and thirteen named risks of an AIF.

16 min read · Worth 10% of the paper · Written from pages 135–197 of the official NISM workbook · Updated 18 September 2026

What an AIF Costs and What Can Go Wrong

An AIF is a pooled investment vehicle. It collects money from investors and invests it as per its strategy. The Investment Manager runs the money. He is paid in two ways: a fixed fee for his work, and a share of the profit if he does well. On top of that, the fund carries a string of other costs.

This chapter is about all of those costs, and about the risks an investor takes on. It then moves on to measuring performance, which we cover in L2 and L3.

7.1 Management fees

The Management Fee (or investment management fee) is what the manager charges for fund management services. It is allocated to every investor pro-rata, based on the value of their investment.

Point	What the workbook says
Rate for Category III	A fixed percentage, 1 percent to 2.5 percent of the Gross NAV (GNAV)
The trend	Managers are moving towards 1 percent to 1.75 percent, depending on scale
When fixed	Pre-determined before launch and stated in the offer document
Accrues from	The date of First Close, up to the date the AIF is dissolved
Linked to profit?	No. Paid irrespective of gains or losses
Payment frequency	"Generally quarterly, semi-annual or yearly", as per the PPM
Paid how	"Generally paid in arrears at a periodic interval like monthly or quarterly", when GNAV is computed
Different for different investors?	Yes. Fees may vary by amount committed and timing, captured as different classes of units

Note that the workbook gives two lists of payment intervals in the same passage — "quarterly, semi-annual or yearly" and then "monthly or quarterly". Both are the workbook's words. If an option lists either set, it is supported.

Incentive fees — the profit share

If the fund earns a profit, the manager also gets Incentive Fees, also called Performance Fees or Carried Interest.

Charged as a percentage of the incremental return, generally between 0 and 20 percent, as per the PPM.
It is an additional cost to investors, allocated pro-rata.
The size can depend on the credibility and track record of the sponsor or manager, type of fund, scheme focus and corpus size.
Its purpose is to align the manager's interest with the investors'.
For closed-ended Category III AIFs, it is paid after the fund tenure ends. For Category III, it is mostly calculated on a 3-year cycle or at the end of the fund term.

The other costs investors bear

Cost	Key facts
Set-up costs (organisational expenses)	One-time. Up to 1.5 percent or 2.5 percent of total capital commitments. Covers offering costs, PPM drafting, registration, intermediary fees, plus GST. Amortised over the first 36 months (or as per PPM) or the entire life, from First Closing
Operating expenses	Recurring. Subject to a limit like 10–50 basis points on NAV or capital commitments, whichever is higher. The limit is yearly
Transaction expenses	Borne on actual basis, without any limits: brokerage, depository charges, custodian transaction charges, securities transaction tax, stock exchange charges
Trusteeship fees	Usually a fixed fee of ₹1 lakh to ₹5 lakh a year, depending on fund size

Operating expenses include legal, audit and tax fees; broken-deal and finder's fees; investor meeting costs (but investors pay their own travel); interest on borrowings (for Category III); insurance for key people; and proportionate liquidation expenses.

What investors should negotiate. Investors should spot avoidable expenses and negotiate a "Cap" on them — trusteeship fees, professional fees, administrative costs, the manager's out-of-pocket expenses, and third-party fees. The best case is to get these netted off against the Management Fee already being paid.

7.2 Hurdle rate

Investors have an opportunity cost — the return on the next best investment. So the manager sets a Hurdle Rate: the minimum rate of return to be accrued to investors every year (or a shorter period).

The return at the hurdle rate is the Preferred Return. It belongs to investors only.
The preferred return is not taken directly into the incentive calculation. The manager earns incentive only on the return over and above it.
In India, hurdle rates are generally 7 to 12 percent a year in INR terms. International norms are 5 to 8 percent in USD terms. The reason given: the Indian market's historical average is estimated around 12 percent.

The tug of war. The manager wants a low hurdle, to earn more incentive. Investors want a high hurdle. So the rate involves serious negotiation.

7.3 High-water mark

A fund may make 20 percent in year one, lose 5 percent in year two and gain 11 percent in year three. The manager should not be paid incentives for recovering his own losses. The High-Water Mark (HWM) prevents that.

Definition: the highest NAV, net of operating expenses, transaction expenses and management fees, achieved at the end of a year. If NAV has only fallen since inception, the HWM is the initial subscription price.

It is used in addition to the hurdle rate.
It is generally applied to open-ended Category III AIFs that allow redemption through Redemption Gates. Incentives in such funds are paid regularly, so an extra threshold is needed.
A consistently rising HWM signals superior performance. An unchanged HWM signals poor performance.

The rule: incentive is earned only on NAV above the higher of the HWM and the reference hurdle.

7.3.1 Catch-up

The Catch-up Rate is the rate at which residual profits — after returning capital and hurdle — go to the manager, so he can "catch up" to his agreed share of total profits. The workbook here describes the performance fee rate as "generally 10–20%".

100 percent catch-up: all residual profit goes to the manager until he has his full share.
40 percent catch-up: 40 percent of residual profit goes to him until he has his share.
No catch-up clause: residual profit is simply split in the agreed ratio. With limited profits, the manager may never reach his full share.

High catch-up rates are preferred by managers. The higher the rate, the greater the risk that investors get a reduced share of the extra return, or none at all.

7.3.2 Gross against net returns

Pre-expense (gross) return uses Gross Asset Value — before expenses, costs, management fees and incentive fees.
Net Return (Pre-Incentives) — after expenses, costs and management fees, before incentive fees.
Net Return (Post-Incentives) — after all of them.

A high incentive pay-out means lower net return. So investors should check the incentive fee for every class of units. All these figures are before direct taxes; the investor's true return is based on the post-tax NAV.

Crystallisation. Some funds have a Performance Fee Crystallisation date. They accrue performance fees daily for accurate returns, but pay them only at the end of the fund term.

7.3.3 GST on fees

Services from fund administrators, registrars, custodians, auditors, brokers and advisers attract GST at 18 percent. Management Fees and Trusteeship Fees also carry 18 percent GST.

The key point: AIFs do not provide services, so they collect no output GST. The GST they pay may not be recoverable as input credit. It is a straight cost to investors. In the workbook's example, GST came to 0.81 percent of the fund's ₹98 crore corpus.

Fund performance and GIPS

Performance is watched by the manager, investors, sponsor, trustees, financial institutions and the regulator. But past performance does not guarantee future returns.

AIFs are recommended to comply with the Global Investment Performance Standards (GIPS). Key points:

Mission: promote ethics and integrity and build trust through standardised reporting.
Performance of schemes is reported in composites, defined by strategy or objective.
Required methods include Gross IRR and Net IRR on a pre-tax basis, time-weighted and money-weighted returns.
Present at least five years of compliant performance (or since inception), adding a year each year up to a minimum of 10 years.

7.4 Investor-level risks

Adverse selection — picking the wrong manager. A track record is no assurance of the future. Result: sub-optimal returns or moral hazard.
Illiquidity and uncertainty — the fund cannot sell at proper exit valuations. Worst when capital calls remain or an investor wants out early.
Fund monitoring — large-ticket investors and Accredited Investors may sit on the Investment Management Committee.
Cash management — uncertain capital calls and exits. Idle cash dilutes returns, so institutions often use an over-commitment strategy.
Underlying investment risks — Category III AIFs invest in listed markets, so they carry capital market risks.
Debt financing risks — credit risk, made up of interest rate risk and default risk.

7.4.2 Fund-level (governance) risks

Fund structure and governance — the most important fund-level risk, "widely known as Fiduciary duty". Covers trustee, manager, committees, valuers and auditors; related party transactions and lack of transparency.
Fund management risks — finding quality deals, concentration, poor structuring, sub-optimal exits.
Macro-level and general risks — regulation, currency, economy, tax changes.

7.5 The named risks in an AIF

#	Risk	The heart of it
1	Market risk	Prices swing and defy rational analysis
2	Performance risk	Loss of investment; speculative strategy; unsuccessful First Close; dependence on the manager; incentive-driven risk-taking; illiquidity; concentration; repatriation; co-investments; geo-political events
3	Counterparty risk	Brokers, banks, custodians may default before settlement
4	Funding risk	An investor does not honour a capital call
5	Interest rate risk	Rate changes hit income and the spread; hedges may fail
6	Foreign exchange risk	Exchange rates, rates and regulatory interference
7	Operational risk	Inadequate systems and controls, human error, management failure; needs BCP and disaster recovery
8	Cyber security risk	Data theft, denial-of-service; incidents reported within 6 hours
9	Country-specific risk	Political and social uncertainty; high inflation leading to corrective measures
10	Legal and regulatory risk	Approvals, tax rates, compliance load
11	Reputational risk	A failed First/Final Close, or poor returns, makes the next fund hard to raise
12	Leverage risk	Category III may borrow up to two times NAV; breaches reported monthly
13	ESG risk	All AIFs must follow a Stewardship Code for listed equity (SEBI circular of December 24, 2019)

Figures inside these risks worth memorising:

Unsuccessful First Close: if First Close is not achieved within 12 months from the date of SEBI intimation, the AIF must file a fresh application.
Concentration: SEBI caps a Category III AIF's exposure to one investee company at 10 percent of the AUM or investable funds, directly or through other AIFs.
Incentive fee risk: the manager may take riskier or more speculative positions to earn more incentive.
No secondary market exists for AIF units.
Data localisation: intermediaries must store data within India and follow CERT (a unit of MeitY) controls.

The Annexure 7.1 template groups PPM risk factors under seven heads: General, Portfolio Investments, Fund Structure, Regulatory, Tax, Sector-specific and Currency. It draws on SEBI's circular of February 5, 2020.

Think of it like this

Management fee is the cook's salary; incentive fee is the festival bonus

A family hires a cook for a monthly salary. He is paid whether the dal turns out well or not — that is the management fee, paid for the service, "not for profit-generation". At Diwali, if the family is happy, he gets a bonus tied to how well he did — that is the incentive fee. And just as a bonus pushes a cook to try harder, the incentive fee aligns the manager with the investors. It can also tempt him to take shortcuts, which is why the workbook lists incentive fee itself as a risk.

The hurdle rate is the fixed deposit you gave up

Mrs Iyer could have kept her money in a safe deposit earning a steady return. When she gives it to an AIF instead, she expects that much at the very least — her opportunity cost. The hurdle rate writes this into the deal: returns up to the hurdle belong to the investors alone. Only what the manager earns above that line is shared. That is why the manager wants the bar low, and Mrs Iyer wants it high.

The high-water mark is the flood line on the village wall

After the great flood, the village paints a line on the temple wall at the highest level the water reached. A later flood only counts as "record-breaking" if it goes above that line. An AIF manager is paid incentive only when NAV rises above its highest earlier level. If NAV falls and then climbs back to the old line, nothing new has been achieved — he has only recovered his own loss, so no incentive is due.

Catch-up is the partner who eats first after the guests

At a shared business dinner, the guests (investors) are served their agreed portion first — their capital and hurdle. Under a 100 percent catch-up, everything left in the pot goes to the host (manager) until he has his agreed plate. Only then is any remainder shared. If the pot is small, the host takes it all and the guests get nothing extra. That is exactly how the workbook's manager took ₹3.45 crore instead of ₹69 lakh.

GST on AIF fees is the toll you cannot claim back

A trucking company pays tolls but can often pass costs on through its own invoices. A family driving to a wedding pays the same tolls and has no one to bill. An AIF is like the family: it provides no services, collects no output GST, and so the 18 percent GST on every fee it pays may not be recovered as input credit. It is a pure cost that comes out of investors' returns.

Key terms in this chapter

CAGR: Compounded Annual Growth Rate: (Ending Value ÷ Beginning Value) raised to 1/n, minus 1.
Catch-up Rate: The rate at which residual profits, after returning capital and hurdle, go to the manager until he receives his pre-determined share of total profits. High catch-up rates favour the manager.
Direct Alpha: A measure of out- or under-performance as a percentage over market returns, found by compounding each fund cash flow forward at market returns and taking the IRR of those values.
DPI: Distributions to Paid-in Capital, the realisation multiple: total distributions ÷ total capital contributions. More meaningful later in a fund's life.
GIPS: Global Investment Performance Standards, recommended for AIFs, which standardise performance calculation and presentation. Firms present at least five years of compliant performance, building to a minimum of ten.
Gross IRR and Net IRR: Gross IRR is computed at fund level before fees, expenses and taxes. Net IRR is computed at investor level treating all those costs as borne by investors, so it is lower.
Gross Net Asset Value (GNAV): The gross value of the fund's underlying investments and liquid balances, after deducting outside liabilities but before accounting for management fee and incentives.
High-Water Mark: The highest NAV, net of operating expenses, transaction expenses and management fees, achieved at a year-end. If NAV has only fallen since inception, it is the initial subscription price. Generally used in open-ended Category III AIFs.
Hurdle Rate: The minimum rate of return to be accrued to investors each year before the manager earns any incentive. In India generally 7 to 12 percent a year in INR terms.
Incentive Fee: Also called Performance Fee or Carried Interest. The manager's share of profit, charged as a percentage of incremental return, generally between 0 and 20 percent, to align the manager's interest with investors.
Internal Rate of Return (IRR): The rate at which the present value of cash outflows equals the present value of inflows. Unlike ROI, it considers the time value of money and gives an annualised rate.
Kurtosis: The degree to which a distribution is more or less peaked than normal. A normal distribution has kurtosis of three; leptokurtic distributions (above three) have fatter tails and are riskier; platykurtic ones are below three.
Management Fee: The fixed fee the Investment Manager charges for fund management services, allocated pro-rata to investors. For a Category III AIF it is 1 to 2.5 percent of Gross NAV, accrues from First Close until dissolution, and is paid irrespective of gains or losses.
Maximum Drawdown: The peak-to-trough decline in AUM during a reporting period, as a percentage of the peak: (Trough − Peak) ÷ Peak. It ignores how often losses occur and how long recovery takes.
Net Return (Post-Incentives): Return calculated on NAV after deducting fund expenses, costs, management fees and incentive fees. Net Return (Pre-Incentives) is the same before incentive fees.
Operating Expenses: Recurring fund expenses charged to all investors, subject to a yearly limit such as 10 to 50 basis points of NAV or capital commitments, whichever is higher.
Over-commitment strategy: A cash management approach used by institutional investors in which forecast capital calls on outstanding commitments exceed current cash balances, to avoid diluting returns with idle cash.
PIC Multiple: Paid-in capital divided by capital commitments. A high PIC means the fund is near the end of its drawdown phase.
Preferred Return: The return generated using the hurdle rate. It accrues to investors only and is not taken into account directly when computing incentive fees.
Reference Hurdle: Called-up capital at the beginning of the year plus the minimum hurdle return on it. Incentive is charged only on NAV above it — or above the high-water mark, if that is higher.
RVPI: Residual Value to Paid-in Capital, the unrealised multiple: AUM ÷ total capital contributions. More representative early in a fund's life, but the residual value is an estimate.
Set-up Costs: One-time organisational expenses such as offering costs, PPM drafting and registration, of up to 1.5 or 2.5 percent of total commitments, amortised over the first 36 months (or as per PPM) or the entire life of the AIF.
Sharpe Ratio: (Portfolio return − risk-free return) ÷ portfolio standard deviation: excess return per unit of total risk. Above 1 is preferable; preferred for undiversified portfolios.
Skewness: The extent to which a distribution is not symmetrical across the mean. Zero for a normal distribution; positive skew has a long right tail and mean above mode; negative skew is riskier.
Standard Deviation: A measure of the volatility of returns around the mean return, used to gauge the historical risk of a fund.
Transaction Expenses: Brokerage, depository charges, custodian transaction charges, securities transaction tax and exchange charges, borne on actual basis without any limit.
Treynor Ratio: (Portfolio return − risk-free return) ÷ portfolio beta: excess return per unit of systematic, non-diversifiable risk.
TVPI: Total Value to Paid-in Capital, the Net Multiple: (distributions + residual value) ÷ paid-in capital, or DPI + RVPI. Equals MOIC when all capital calls are met.
Value at Risk (VaR): The maximum expected loss for a fund over a given time frame at a pre-defined confidence level.

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Original explanatory writing based on the official NISM workbook for Series XIX-E, which is published and copyrighted by NISM. Check figures against the current edition at nism.ac.in.

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