Checking fee bases before comparing products
Series XIX-A case study · set 1, case 3 of 5 · 4 questions · 1 mark each
Question 1 of 4Case practice
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The case · stays here for all 4 questions
The Lake Fund has commitments of ₹120 crore and has drawn ₹60 crore. During its three-year investment period, its signed agreement charges a management fee of 1.5% per year on commitments. After that period, the fee becomes 1% per year on the cost of investments still held. At the first year-end after the switch, that cost is ₹50 crore. The agreement also permits a separate annual administration expense of ₹0.20 crore. For this exercise, ignore GST, carried interest, intra-year changes and every other expense. A distributor’s draft brochure incorrectly describes the 1.5% fee as applying only to drawn capital and says that the fee includes administration.
All fees and fee bases are hypothetical contractual terms.
Each calculation is for a full year.
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The case and its answers
Every question of this case, with its answer and why each other option is wrong.
The Lake Fund has commitments of ₹120 crore and has drawn ₹60 crore. During its three-year investment period, its signed agreement charges a management fee of 1.5% per year on commitments. After that period, the fee becomes 1% per year on the cost of investments still held. At the first year-end after the switch, that cost is ₹50 crore. The agreement also permits a separate annual administration expense of ₹0.20 crore. For this exercise, ignore GST, carried interest, intra-year changes and every other expense. A distributor’s draft brochure incorrectly describes the 1.5% fee as applying only to drawn capital and says that the fee includes administration.
All fees and fee bases are hypothetical contractual terms.
Each calculation is for a full year.
Q1What is the annual management fee during the investment period?
Option A. ₹1.20 crore
Why it is wrong: This applies 1%, not 1.5%.
Option B. ₹0.90 crore
Why it is wrong: This uses drawn capital although the contract specifies commitments.
Option C. ₹2.00 crore
Why it is wrong: This adds administration to management fees.
Option D. ₹1.80 crore — Correct answer
Answer: D. Management fee = 1.5% × ₹120 crore commitments = ₹1.80 crore. Using ₹60 crore drawn capital would incorrectly cut this fee in half. Remember: Check both the percentage and the fee base.
Hint, shown before you answer in practice mode: The agreement, not the brochure, identifies the base.
XIXA-S1-C03-Q1easynumerical
Q2What is the annual management fee after the stated switch?
Option A. ₹0.60 crore
Why it is wrong: This uses drawn capital rather than the cost still held.
Option B. ₹0.75 crore
Why it is wrong: This keeps the old 1.5% rate.
Option C. ₹1.20 crore
Why it is wrong: This keeps commitments as the base after the switch.
Option D. ₹0.50 crore — Correct answer
Answer: D. The new fee is 1% × ₹50 crore cost of investments still held = ₹0.50 crore. Neither the old commitment base nor the old 1.5% rate applies. Remember: A fee step-down can change the rate and the base.
Hint, shown before you answer in practice mode: Both the rate and the base change.
XIXA-S1-C03-Q2mediumnumerical
Q3What are the combined annual management and administration charges during the investment period?
Option A. ₹1.80 crore
Why it is wrong: This omits the separate administration expense.
Option B. ₹0.20 crore
Why it is wrong: This includes only administration.
Option C. ₹1.10 crore
Why it is wrong: This uses the incorrect drawn-capital management fee.
Option D. ₹2.00 crore — Correct answer
Answer: D. The annual charges are ₹1.80 crore management fee + ₹0.20 crore administration expense = ₹2.00 crore. The case excludes carried interest, taxes and other expenses. Remember: A management fee may not cover all fund costs.
Hint, shown before you answer in practice mode: Add only the two stated charge categories.
XIXA-S1-C03-Q3mediumnumerical
Q4What should the distributor do with the draft brochure?
Option A. Describe the management fee as a performance guarantee.
Why it is wrong: A fee does not promise investment performance.
Option B. Correct the fee base and separate expense disclosure before using it. — Correct answer
Option C. Use it because the fee percentage is correct.
Why it is wrong: The wrong base and missing expense change the investor’s cost understanding.
Option D. Replace the signed agreement with the brochure wording.
Why it is wrong: A brochure does not unilaterally amend the signed terms.
Answer: B. The brochure understates costs by using drawn capital and by folding administration into the fee. Accurate disclosure requires correcting both errors before relying on the brochure in a discussion. Remember: Explain total costs using the actual contractual terms.
Hint, shown before you answer in practice mode: Check the brochure against the signed economic terms.
XIXA-S1-C03-Q4easyapplication
A simple distribution waterfall without catch-up
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