Fund accounting

Fund accounting:

Companies like HDFC asset management company (AMC) pool the

money from investors (Like salaried employees, students, small
business etc),invest that money into various assets like shares,
bonds/debentures/gold etc, distribute the profits /losses to
investors.

Eg: SBI launched a mutual fund (sbi large cap fund ) in Jan 2020,
pooled rs 100 crores ,invested that money in shares of reliance
,Infosys, tcs etc. share prices are increased so the fund value/net
asset value ( net asset value/(asset-liab)) Is increased to investors
give money to these AMC’s/fund houses like
HDFC/SBI/BLACKROCK/JP MORGAN etc since these AMC’S are
experts in understanding different assets likes shares ,bonds, real
estate etc, they know what is right time/price to buy and sell. If
investors directly invest in these shares directly in these
shares/other assets they may pay more to an asset or they may buy
an asset which is not worthy/making losses so they can get negative
return/loss in all their investments.

These AMC’s will have research analysts who will find out the best
investment opportunities across the globe.

They also have the best risk management practices or reduce the
loss if market is falling like diversification ( investments into many
stocks rather than investing in single company), use hedging ( like
use futures/options or other derivatives contract to reduce loss)
etc.
So, over a period , wealthy investors also started investing into
these funds launched by AMC’s so the assets managed by them is
growing . in India mutual funds , AUM (asset under management) has
grown from Rs 6 lakhs crores in 2012 to 38 lakhs crores in 2022.
Worldwide also growth is high.

To offer different type of investment opportunities to these

investors , these AMC’s also launched different type of funds like
equity funds that invest in shares, debt funds those invest in bonds
etc.

1) Mutual funds
2) Private equity / venture capital funds
3) Hedge funding

(refer some videos in YOUTUBE like blackstone jp morgan and

suggestions to know about a market and how it works and search key
words for better understanding)

1)Mutual funds :

Pool the money from investors( mainly from retail investors like
salaried employees) and invest that money in less risk assets like
shares of limited companies ( like reliance , tata, apple whose shares
are available / listed in stock exchange like BSE) , bonds issue by
govt. etc. risk is less here since those well established companies,
they can sell / issue to public only after regulators like SEBI
approves.

2)Private equity :

Private equity and venture capital funds pool money from wealthy
investors like high net worth individuals (HNI), individual investors
like LIC/PENSION FUNDS , sovereign wealth funds( funds owned by
govt like Dubai) etc. who can invest more money and ready to take
more risk (accredited investors). Since these investors can afford
to take risks. These funds are less regulated/controlled by
SEBI/Other regulators so these funds can invest in any assets.
Generally they invest in shares of private companies (start up’s) /
real estate assets like office park/ shopping malls etc. or into
infrastructure assets like roads , airports etc.

3)Hedge funds:

hedge funds also pool money from wealthy investors and they can
also invest in any asset class. Generally they invest in public company
shares, derivatives like futures and options, bonds, currencies etc.
they generally invest for short term period and take more risk then
mutual funds and P/e ( PRIVATE EQUITY) funds.

11-3-2022

Common practices in the industry is an AMC company HDFC

AMC/JPM asset management /KKR etc launch the funds and they
will concentrate on where to invest the money by doing research on
stock/assets like real estate /gold ,and they outsource all other
activities of the fund to other companies like STATESTREET/BNY
MELLON, called as fund companies. These fund admins take care
about all day to day activities of the fund like recording all
transactions of the fund like investment made by fund , recording
gain/loss of investments etc. report the profit/loss(net asset value)
of the fund investors, file returns to tax authorities and like SEBI
OR SEC(securities exchange commission of USA) provide audit
support to complete audit etc. these fund admins main work is
accounting for the funds so fund accounting is source of income,
more the fund that administer , more the fees they get (for AMC,
investors pay management fees, for fund admins, admin fee is paid,
both are charged in the fund/collected from investors) .

Similar to AMC, fund admins, these are other intermediaries in the

industry like .

a) Auditor who has to complete the audit.

b) Custodian : who keeps the asset of the fund like shares in
their custody.
c) RTA(register and transfer agent): who keeps the record of
all investors in a fund, record any transfer between
investors.(if RTA gives the list of investors in a fund at time
like 31,march 2022, that is the final data that can be used by
auditors/regulators etc).
d) All professionals like asset valuers, tax advisors, legal experts.
etc.
e) Prime broker/stock broker party who buys/sells securities on
behalf of the investor.

Mutual fund
Life cycle of a mutual fund:

1.launch the mutual fund, collect money from investors during

NFO(new fund offer) period

2. invest that money in to stocks/bonds etc

3.calculate NAV on a daily basis by taking market value of

shares/securities.
4.allow subscriptions/investment by new investors where fund will
sell new units to investors at NAV price.

5.allow investors to exit the fund (Redemptions/repurchases) and

settle their accounts by taking units and paying.

6.if it is a closed ended fund the fund will not allow subscriptions
and redemptions rather they will list the units in exchange so the
investors can directly buy/sell in stock exchange.

7.if open ended fund they can continue forever if investors are
there in that fund. if closed ended, they will sell all investments at
the end of the life time of fund and return money to investors and
close the fund.

AMC/FUND HOUSE/INVESTEMENT MANAGER – Goldman sachs

Custodian and fund administrator - state street

RTA - KARVY, computer age

Auditors - KPMG

Tax auditors - Public tax consultant

14-03-2022

Private equity:
Private equity funds pool the money from wealthy investors (HNIs,
investors etc) and they can invest that money in to any asset and
give returns to investors after selling these assets they generally
invest in shares of private companies/startups, real estate
properties like shopping malls, IT parks or infrastructure projects
like airports/highways etc most of the times they invest in ”illiquid
assets”(assets those cannot be sold or converted in to cash easily)
like real estate so they cannot promise to the investors that they
can redeem/withdraw money when they need so, they generally
launch these funds as closed ended funds with life time like 10
years. if you have invested in a fund launched by black stone in 2022,
you may get that money in 2032, not before that.

Since they invest (generally) huge amount of money into one company
like Byjus, Oyo rooms etc, they cannot exit/sell that investment in
short time like 1 or 2 years with good profits.so, they invest for long
term like 5 to 10 years so the investment can be increased by good
% like 100% to 500% like that so they can make more profit. Since
they generally invest huge amount and take major stake in the
company or asset like from 5% to 95%, they cannot wait for the
asset/company to grow on its own and then sell that asset, these
funds generally involve in the decision making in the company so they
can understands the business better and suggest that company on
the best practices like best technology to be used , best marketing
strategies to be followed etc.
15-03-2022

These funds( generally ) launch as closed ended funds a life time like
years . the cycle of fund / list of activities in that fund for those 10
years is as below(tentative)

Each state will take sometimes since the most of the investments
these funds made are not popular/information about these assets /
companies is not publicly available.

Eg:

If the American fund like Carlyle fund want to invest in Indian

startup company like Rapido bikes , they have to get the details
from management, understand the risk in the business, negotiate the
price per share and then invest. So these process may take
approximately 3 to 6 months per an investment.

similar to investments, exits also will take time since they have to
sell these companies for huge amount like 5000cr plus in most of the
cases, so finding a buyer who can invest that much money is not easy.
sometimes, approvals for process like IPO also takes time since the
business is new and regulator like SEBI may take time to approve
that IPO.
These private equity funds are different when compared to mutual
funds or hedge funds mainly due to below features

A. they generally invest for long term like 5+ years in each

investment

B. they are generally launched as closed ended funds so investors

will have low/nil liquidity (investor cannot withdraw from the fund)

C. these funds generally take major stake in the company so the risk
is high if that business fails, so they monitor the business closely
including involve in the decision making of that business.

Launch:
before launching the P/e or hedge funds, these fund houses like
KKR/Goldman sachs /Blackstone etc reach out to investors with all
the details about the proposed fund like duration of the fund, where
the fund is investing (startups ,real estate etc), the track record of
that fund house in managing similar funds earlier etc.

All these details, they will mention in a document/prospectus, called

as “private placement memorandum (PPM)”.

once they have details like approximate number of investors

interested to invest in that fund, money they want to invest, country
they belong to etc., the fund house can get more clarity on the type
of registration they can go for and number of funds or sub funds
they have to register to manage that fund etc.

# very common type they use to register these funds is limited

partnership (LP) where all the investors and fund manager will
become partners in that fund, that fund will be closed after the end
of the duration like 10 years.
# common issues a fund has to address/resolve at the time of launc
h of the fund is , here few insights

1)Taxation issues:

when the fund has international investors which is common in p/e

funds, they may face double taxation issue where the investor may
need to pay tax in that country he belongs to and he may have to pay
tax in the country where the fund is registered.

Ex: Amitabh invested in Carlyle fund registered in America, he may

need to pay tax in India and also in America.

2) Regulatory Issues:

some investors/investors from a specific country may not be allowed

to in or they may have to get more permissions to get the approvals
to invest in a country.

Eg : #if an investor from china want to invest in India, they

generally need more permissions like permission from home ministry.

# if an investor from Russia want to invest in American fund

that will be restricted/not allowed.

One of the common routes they take to reduce these issues/avoid

are,

# Register multiple funds with in the same fund structure, mostly

these funds in different countries so the tax liability can be voided
or reduced to investors from different countries or regulatory
issues like any prohibitions will not stop the fund from taking
investors.
Eg : Register a fund in America which is a master fund/main fund
and register a sub fund/feeder fund in a tax haven Country like
Mauritius /cayman island/Singapore etc.

16-03-2022

once the list of investors are finalised, they will also finalised the
structure like how to register (generally limited partnership (LP)),
where to register (generally one master fund in America and one
feeder fund in Cayman islands), they will take commitments from
investors (maximum amount an investor can Invest in that fund),
they will have closes or first close in that fund (no further
investments to be allowed in that fund at that stage). if need more
capital they can have 2nd close where few more investors will be
allowed in to the fund. generally, they will have 2 or 3 closes with in
18 months from the launch of the fund(there are funds with one
close also means no further investments from investors in that fund
once launched).

Key terms-Launch of the fund

Limited partnership(LP): most of the P/e(private equity) or

hedge funds are registered as limited partnership entity (like mutual
funds are Registered as trust).

eg: If KKR launched a fund in America and pooled 10000 cr from 4

investors, they will register separate fund, all these 4 partners and
fund manager will be part of that fund. fund can be registered with
name “KKR infrastructure fund(Asia) L.P another form used to
register these funds is LLC/limited liability company.
Limited partners/LP’s:
these are the investors in a fund that is registered as limited
partnership.

ex: if Tata, kohli, sindhu, priyanka invested in one fund, each 100cr,
they are limited partners in that fund

They do not participate in the business of that entity/fund, rather

they only invest the money and take profits/losses.

Their liability is also limited to the extent of their

investment(commitment).

Ex: If kohli committed rs 100cr in the fund, maximum amount of loss

he can incur is that 100cr, if the fund’s losses are more and his
portion of loss is 150cr also he need not pay the remaining 50cr. (one
of the scenario to get that more loss is the fund took 400 cr from
investors and borrowed 600cr, invested 1000cr, loss is 800cr.in this
case each partner loss is 200cr, though they invested 100cr)

General Partner (GP):

This is the main partner in the fund that is registered as LP. this
partner manages the fund, take decisions on where to invest, when
to invest or sell etc , since this partner manages the fund/business,
he should have unlimited liability.

eg: in the above case, total capital is 400cr, loss is 800cr so extra
loss of 400cr this partner has to pay.

however, GP need not be individual person so they register that as

company like “KKR GP LTD”, or “ICICI GP LTD” etc and appoint that
company as GP. assuming the capital/net assets of that GP is 1cr, the
creditors in the fund(like bank Who gave loan to the fund) can only
recover rs 1cr,the net assets in that fund So, most common
structure is register the fund as LP, have limited partners and one
GP (registered as company).

LPA-Limited partnership agreement:

This is the agreement between GP and LPs in a fund that is
registered as limited partnership entity this agreement will have all
details about that business/fund like

1. tenure/duration of the fund like is it for 10 yrs/15 yrs etc.

2. management fee terms like if the partners will pay 2% fee or 1%

fee in that fund.

3. how the profits will be distributed between partners (Waterfall

provisions)

4. terms and conditions like how and when the fund can be liquidate,
if there is any expense cap like maximum expenses in the fund can
be 2.5cr not more than that etc

Commitment:
This is the maximum amount an investor is ready to invest in a fund.
each investor commits a certain amount like 10cr, 100cr etc based on
their capacity /willingness to invest in that fund at the launch time.
fund can ask them to invest/call that money from them when the
fund need.
The fund generally calls/take 10% of money in 1st year, 30% in 2nd
year etc .in 3 to 4 years, they will collect all the money/committed
amount from that investor and invest that.

Close:
when the fund finalises the list of investor and their commitments,
they announce a close which means new investors are not allowed in
to that fund.

Ex: ICICI private equity fund had close in feb 2022, they have
raised rs 5000cr from 10 investors. if you want to invest rs 10 cr in
that fund, they will not allow since they have finalised list of
investors and fund had close.

if they need more money, later, like after 6 months they can have
2nd close and accept more investment like 100cr from old/new
investors, that is 2nd close.

all these closes are also called a subsequent closes.

17-03-2022 note
Master fund

Master fund , feeder fund:

EG:

Fund Warburg pincus india fund

Commitment/size 3000 crores
Investors Buffet , elon musk, Ronaldo and
govt of Dubai.
Investments Airtel , sbi life insurance, PVR,
kalyan jewelers ,boat , IDFC
,first bank.
Vintage year 2010
Master fund Warburg India ( venture capital)
fund LP
Registered in Delaware, USA

INVESTORS STATUS COMMITEMENT LIABLITY

Buffet LP 500 LIMITED
MUSK LP 600 LIMITED
Warburg india LP 2890 LIMITED
fund(cayman)
LP
Warburg pincus LP 10 LIMITED
GP.ltd
3000 crores
War burg india fund ( cayman) LP:

Investors Status Commitment Liability

Ronaldo LP 390 LIMITED
Govt of dubai LP 1500 LIMITED

Master fund is the main fund in in fund structure, this is master

fund / main fund since one of the below features it will have.

A) the decision maker/GP will be in the fund.

B) Most of the investments are reported in this fund( if fund has 10

investments, more then 7 may be owned/invested in same ) in the
name of master fund.

C) most of the investors/commitments will be from this fund.

It is very common to have these funds registered in the main

country from where the GP and most of the investors came from.in
the above example GP( Warburg company) and most of the investors
are from America so they register in USA, that is also called as
Onshore fund (for India fund launched by ICICI, master
fund/onshore fund will be in India)

So, in most of the cases/generally Master fund and onshore fund

both are same.

Feeder fund is mainly registered to FEED the money of few

investors (mostly foreign investors) in to the master fund.

ex:

if master/onshore fund is registered in America, if there are

international investors like Ronaldo (Portugal), they may have t pay
tax in america and in portugal.so, the fund can register separate
company/partnership entity in Cayman islands and accept/register
these investors in that fund/partnership/company, that fund/entity
is called as FEEDER.

# This FEEDER will collect money from the investors in that feeder
fund and send/feed money to master fund.in master fund, these
international investors names will not be reported as direct
investors rather the feeder name will be reported as investor.

These feeders are commonly registered outside the main country( in

this example America is the main country/onshore) to take money
from international investors , so these are also generally called as
off shore funds . ( offshore funds means a fund outside the country
where the main fund/ GP located, for America fund, all funds
registered outside America fund, all funds registered outside
America is offshore. It can be any Cayman/ Mauritius Luxemburg
etc.)

BLOCK ENTITY/BLOCKER:
This is one of the entity like company/partnership etc registered
with in a fund structure, mainly used to block/reduce the tax
liability at one investment level(some times feeders also called as
blocker as those entities also block/reduce investors tax liability)

ex:

Warburg pincus India fund LP want to invest in Oyo rooms in India,

if they directly invest from America in to Indian company, they may
have to pay tax in India on profit made on sale of oyo rooms in
future.to avoid that, they can register separate company in
Mauritius (name can be Warburg Oyo limited), that company invest
in India. In Oyo rooms company, the share holder name is Warburg
Oyo Itd, not the main company, so they need not pay tax in India.

Vintage year : this is the first year of the fund.

Ex : warburg pincus India fund Lp vintage year is 2020..

Fund size : total commitments in the fund are called as fund size.

ex: Blackstone India fund Lp fund size is 2000 cr, now increased to
rs 4000 cr after 2nd close...

Investor cash flows:

Table -1

Table – 2

Number Indian number Common usage

format
1000 Thousands Salaries
1000000 Lakhs Car price is 1 million(
10 lakhs)
1000000000 Hundred crores 1.4 billion india
population
1000000000000 1 lakh crores India’s GDP is 3
trillion
Private equity fund -Investor cash flows
In mutual funds, hedge funds, Investors will pay the money to the
fund house at teh time of launch itself.

Ex:

If a mutual fund is launched on 1st jan, launch period is up to 15th

Jan, all interested investors can give money to the fund house at
that time and fund will invest that money by end of jan,
approximately In P/e funds, these funds raise huge amount of money
like 10000 crore and above (mostly), and it will take time like 3 to 4
months to make each investment, so, the fund might take
approximately 40 to 48 months to invest all the money if they invest
appx.10 investments

Ex:

If KKr launches a fund with fund size of 50K crores, they may invest
in to companies like byjus, oyo rooms etc.If they launched the fund
on 1st jan 2022, they complete the investment period (making
investments) by 2026 to avoid keeping this investors money idle for
years appx., these funds do not collect money from investors at the
beginning, they only take commitment from each investor and then
collect/call the money from them when need the money.

ex:

If dhoni want to commit/ready to invest rs 100cr in KKR fund, he

can commit that in 2022 jan. fund will collect 20cr in 2022, 40cr 321
in 2023 etc., when ever they find the opportunity to invest ,

same way, the fund will distribute the money to investors when ever
the fund has money.if the fund receives cash in the form of
dividend, interest etc or receives money by selling an asset, they
distribute that money.

ex:

Fund may distribute rs 10cr in 2022, 50 cr in 2023 etc., till the end
of the fund's life time, they will keep distribute the money.

When the fund calls money, investor failed to pay that amount, he is
called as delinquent/defaulted investor, that investor has to pay
delinquent interest to the fund like int at 6% per year for those
number of days the payment is delayed.

if the partner continues to default, The Gp can take appropriate

decision like

a) transfer that stake to new partner or another partner the fund

b) continue the fund with less commitments like the commitments

are now 900cr, earlier 1000cr.

Key terms-Investor cash flows

Commitmnet

This is the amount an investor in private equity fund agreed to

invest in a fund.

Ex:

if amitabh commits rs 100cr to ICICI fund, the maximum amount

the fund can collect from him is rs 100cr.The fund can collect this
amount any time in the life time of the fund. generally they collect
around 20%first year, 30% in 2nd year etc.

generally, this commitment includes the management fee payable by

the investor to the fund house.

Ex: If amitabh commits rs 100cr, fee rate is 2%, he need to pay rs

2cr per year as management fee to the fund house for managing his
money. assuming the fund life time is 10 yrs, his fee is rs20cr.so,his
contribution towards investment is only rs 80cr

however, in some funds, the management fee is outside commitment

which means the investor has to pay fee over and above the
commitment amount.

if the fund takes loan then the fund manager can decide whether to
first take investors contribution out of commitment, 346 or to use
the loan amount/part of loan amount first and then investors money
out of commitment to make investments

if the fund takes loan then the fund manager can decide whether to
first take investors contribution out of commitment, or to use the
loan amount/part of loan amount first and then investors money out
of commitment to make investments or to pay expenses in the fund
like management fee.

ex: investors committed rs 100cr and fund took rs 100ccr loan. if

the fund want to invest rs 50cr in oyo rooms, fund manager can take
that amount from loan and invest or call from investors.
Capital call, contribution:
when the fund need money to invest in assets or to pay expenses in
the fund, they will issue capital call notice and ask money from all
investors.

investors will be given approximately 15 days time to pay that money

to the fund. these are also called as drawdowns since the fund is
taking/drawing(withdrawing) money from the commitments already
made .

When the investor send/pay that money to fund, it is called as

contribution.

Distribution:
when the fund has money, they send/pay that money to investors
this can happen at any time in the life time of the fund like in the
1st year or 10th year. however, good amount of distribution will
happen towards later part of the fund's life time like after 7th year
when the fund started selling its assets all distributions can be
grouped in to the below

1.income distribution -if fund receives interest/dividend/rent etc

and distributed that money to investors, it is income distribution.

2.capital distributions-amount received by selling an investment is

distributed, it is capital distribution

3.In Kind distribution- if fund distributes any assets of the fund

rather than cash it is in kind distribution
ex: carlyle fund invested in SBI cards company, that company went
for public issue of shares/IPO(initial public offering) ,shares are
listed in Bombay stock exchange. this fund can distribute remaining
shares to investors, they can sell in the market later when they need
money.

Recallable Distribution:
when the fund has money by selling an investments, they distribute
that money since they may not find any investment to invest since
they deal with illiquid assets(generally)

so, reinvesting that money again is not possible. however, if the fund
manager(GP) thinks, they may get an opportunity to invest more in
the near future, they can consider that distributed money as
recallable distribution.

this means, investors has to plan to re invest/contribute to the fund

when they asked/called that money in future. GP can consider these
distributions as recallable if that is mentioned in LPA, else, all
distributions made can be spent by the investors as per their wish.
if it is mentioned as recallable distribution at the time of
distribution, investors has to plan and then reinvest later when the
fund calls it.

ex: carlyle fund started in 2020, invested in HDFC bank. they sold
the investment in 2022 and distributed rs 1000cr, 80 considered rs
500cr out of that as recallable distribution. now, investors can spend
rs 500cr, has to plan to reinvest remaining 500cr in the future when
the fund calls that money
Under commitment:
This is the remaining commitment for an investor.

Eg:

Priyanka committed rs 100 crores in 2020 , paid 10 crores in 2021

and 20 crores in 2022. The UFC/UN FUNDED COMMITEMENT is
100-10-20=70.

So UFC = COMMITEMENT-CONTRIBUTION.

If there is any recallable distribution, there will increase the

investors UFC.

EG: in the above case the fund distributed and 20 crores is

recallable distribution in that. Then , the UFC is (100-10-20)+20=90

FUND NAME KOTAK SPECIAL SITUATION

FUND
Commitment 5000 crores
Investors Sharukh, Arjun, kattappa, katrina
Investment Nuvoco, HKR( gayatri projects),
Jindal,SIFY
21-03-2022

Management Fee:

Q : is it income or expense in the fund like carlyle asia fund LP?

it is an expense in the fund

this is payable by all investors to the GP/fund house like carlyle fund
is owned by investors so expense of the fund is expense of investors

Q: why and when this expense is payable by investors to the GP/fund

house?

for managing the assets/investments of the investors, the investors

must pay this fee to the fund hiuse, it is always recorded as expense
in the fund books.

this is generally paid in arrears (means after the period like pay in
april for jan to march quarter) o in some funds paid in advance(pay in
first week of jan for jan to march period)

Q: how it will be charged to investors/on what basis?

in case of mutual funds and hedge funds, it is based on net asset

value (NAV),generally as 1 to 2% on NAV

ex : if the assets of the fund is 100cr, liabilities are 10 cr, Net

asset value is 90cr(100-10)

if the fee rate is 2% per year then the fee for that year is 90cr*2%
= 1.8cr(1 quarter can be 1.8/4 =45lacs)
as In case of P/e funds, the NAV can also be zero or negative in
first quarter or year if they don't collect any amount from
investors.

so, generally they collect the fee on commitment only. if you

committed rs100cr to the fund, fee rate is 2%, you will pay r2cr per
year, all 10 years if the fund life time is 10 years

however there are different type of methods in p/e funds, based on

negotiations between GP(or investment manager/fund house), LPs
(investors), they will decide one method at the time of launch and
they will continue to use that method. most of the times, same
method till the end of the fund's life time, some times, they will
change the fee method from one method to other(say commitment
method to NAV based method), if agreed at the beginning.

ex: fund launched in 2010, life time is 10 years. they have agreed to
pay fee on commitment basis for the first 4 years an based on NAV
for the remaining 6 years.

Q: If the fund says 2% management fees on commitment / NAV etc,

it is paid for fund manager efforts / time or any other reasons?

this fee includes the fund manager time and efforts and also all
common expenses they have incurred to manage the fund like
salaries to their research team, rent to their office etc)

in the fund books, we do not see these expenses like salaries, rent
etc., since the fund will not have any employee or office separately
for that fund.
we can only see management fee as major expense in any
fund(MF/PE/HF), other prof fees like audit fee etc.

Q:all P/e funds will follow same method or 1 or 2 methods to charge

the fee?

each fund can have diff methods based on negotiations at the time
of launch. negotiation can be based on 41.efforts of the fund
manager, if more efforts they will tray to take more fee and find
better method that will pay them more.

2.reputation of the fund house-reputed fund house like KKR can

charge more fee/can convince the investors to pay the fee based on
the method which will give them better fee.

3.reputation of the investor/invested money-some investors like

govt.of Dubai can invest huge amounts so they can negotiate the
better method for them where the fee can be less for them.

based on all these, there are different methods in the industry and
also there are many adjustments where the fee rate can go down
over a period, diff. investors pay diff fee rates in the same fund
etc., commonly followed methods are

1 commitment based

2.cost of the investment/invested capital

3 NAV based fee

4.switch based/conversion method

5 fixed amount per year

 1)commitment based method :
in this method the fund will charge the fee to investors on their
commitment from the beginning of the fund till the
close/liquidation of the fund.

ex: if you have committed rs 100cr,fee rate is 2%, you will pay
rs 2cr per year ,all 10 years. even if the fund invested rs

10cr out of your 100cr commitment, you still need to pay on 100cr
commitment.

since the fund manager efforts are there from the beginning of teh
fund to find out the investment opportunities, they charge the fee
from the day 1 on commitments, this is most commonly used method
in private equity funds.

Fund name Softbank vision fund

Investors Commitement in (crore)
Dubai govt 350000
Khatar govt 150000
Softbank 200000
Others 50000
Total commitment 750000

Fees on 2% on commitment .

Vintage year 2017- vintage year means beginning year/ the fund.

Fees calculation for the year 2021 ( same for all years) generally
they calculate on quarterly and send invoice.
generally they collect fee on a quarterly basis in arrears(after the
close of the quarter) nex for January to March 2021 period(Q1
2021), they will send the invoice to investors in April, by 15th apr 21.

2 Cost of the Investment/Invested capital:

In this method investors will pay fee only on amount invested by the
fund.so fee amount can be less Fee for the year is calculated
below(not quarter) each time fund invest some money, fee base will
increase, apply fee rate on that amount till the next investment is
made fee base changes again if the fund invest)

Fee is 829.32.

Calendar year – jan to dec 2021, numbers are in US date format

MM/DD/YYYY

total fee for 2017 is 829.32 cr(428.49+350.96+49.86).this will be

allocated to all partners for that year based on their ownership Ex:
If Dhoni has 10% commitment /ownership in the fund, he will be
allocated rs 82.9 cr for 2017 (assuming all partners in the fund paid
fee or fee free investors like GP has very negligible amount like 100
dollars is invested) If the fund is allowed to take leverage/borrowed
capital, then total investment can be more than the commitments,
total fee can be more than the commitment based.

Ex : Commitments are 7.5 lacs crores, if the fund borrows 5 lacs

crores, total investment will become 12.5 lacs crores so mostly the
fee amount in 10 years will be more than commitment based (even if
30% invested in 1st year and 100% invested by 3rd/4th Year) If no
leverage/borrowed amount is allowed then the fee earned by GP will
be less in this method since all the committed amount es will not be
invested at a time as the problem for the investor is, they are
making GP to invest all money soon to get the fee revenue so they
may invest money with out proper research and that may give lower
return on investments.

3: NAV BASED METHOD :

In the case ( similar to mutual fund / hedge funds), P/e funds also
charge the fee based on NAV of the fund. NAV stands for net asset
value, if the funds assets are Rs 1 crores, liabilities are 20 crores ,
net assets are Rs 80 crores (100-20). If the fees refers 2% , then
the fees is 1.6 crores (80*2%) if the fund is charging fees on
quarterly basis , they will collect fees of Q1 2022 in april. Based on
NAV of Q1 2022 ( jan to march).

Some times, they will not have NAV numbers ready to bill the
management fee of that quarter so they will use the latest NAV
numbers available to bill provisional management fee(temporary),
then the balance will be adjusted as True up/true down .

ex: if they are raising fee invoice on 15th April for Q1 2022, NAV of
Q1 2022 is not yet finalized, then they will use Q4 2021 NAV and
raise the invoice. Assuming Q4 2021 NAV is rs 100cr and Q1 2022
Nav is 150cr, they will raise the invoice for balance fee on 50cr as
true Up or they will include this in next quarter fee invoice.

22-03-2022

4.Switch based/conversion method:

in this case the management fee method will be changed from one
method to other method over a period.

ex: fee is charged based on commitment till the end of 4th

year(investment period), from 5th year, fee is charged based on
invested capital/cost of investment.

in this case the GP will get time to research and make investments in
first 4 years rather than invest in hurry to get more fee. also,
indirectly it will put pressure on GP to invest all money by 4th year,
else, the fee will be less if they invested less money generally, first
4 years of the fund is defined as investment period means the fund
should complete the investment activities with in this time.so in LPA
they mention, till investment period end, fee will be based on
commitment and later It is NAV based or invested capital etc

5.fixed fee:
in this case they will fix the fee like 20L in the first year, 18L in 2nd
year, 16lacs in 3rd year etc..
Adjustments

these investors/GPS negotiate certain terms mainly based on

efforts of the GP or risk taken by Investor.

1.Step down method/adjustment:

in this case the fund will charge lower fee over a period if the fund
manager efforts are expected to be less in the later part of the
fund's life time

ex: if the fund is following fund of fund method, the GP efforts are
more in first 4 years to find the investment 524 opportunities, later
the efforts can be less so they can agree the fee rates like below.

Year Fee rate terms Effective rate

1 to 4 Normal rate 2%
5th year 75% of previous year 1.5%
6th year 75% of previous year 1.125%
7th year 75% of previous year 0.84375%

2. tier based fee:

Fee from the investors will be different mainly based on the amount
they invest.

Investment by investors Fee rate

Upto 100 crores 2%
Above 100 cr to 500 crores 1.75%
Above 500 cr 1.50%
3.side letters:

LPA terms applies to all investors in the fund. if fund want to give
some exception to one or set of investors, they can 538 enter in to
separate agreement/side letter with them.

ex: if carlyle has only one fund in 2022, they have charged 2% fee to
all investors.in 2023, they launched 2nd fund, if an investor from
fund 1 also invested in fund 2, they can give 0.25% discount/lower
rate in fund 1 also. for this reason, they have issue side letter to
those investors in fund 1 and charged lesser fee.

4.Fee free investors:

Some investors in the fund will not pay fee, they should be excluded
from fee calculations

ex: below categories of investors will not pay fee

1.General partner, carried interest partner

2.employees of the fund house(Goldman sachs employees in gold man

funds)

Carried Interest(carry) /Incentive Fee/performance fee/waterfall

provisions

in private equity and hedge funds, it is a common practice to share

the profits with the GP/fund house if they generate 550 good
returns in the fund. generally, investors share/pay 20% of profits
with GP/fund house
ex: you have invested rs100cr in the fund, fund gave 100cr
return/profit. you will pay rs 20cr as incentive fee/profit 552 share
to GP.

this % of sharing in profits and whether to have this incentive fee in

the fund or not etc are decided by investors and GP based on the
negotiations at the time of launch and included all these terms in the
LPA.

these terms in the LPA defines the hierarchy of cash flow

distribution in the fund, these provisions are called as "waterfall
provisions" most common hierarchy of cash flow distribution that is
agreed in these funds is

1.pay 100% principal to the investors (LPs, GP portion also that is

invested)

2.remaining cash, pay to investors as preferred return(generally at

8% per year on invested amount)

3.reamaining cash, to the GP as catch UP(generally 20% on preferred

return paid in step 2 above)

4.remaining cash, sahre between GP and LP,in 20:80 Ratio (generally,

where 20% goes to GP and 80% to LPs)

Ex: If carlyl asia fund is launched on 1st Jan 2022, collected rs

100cr, invested in 2companies (OYO and CRED), sold both the
investments on31st dec 2022 and got rs 200cr.this cash will be
distributed as below.
There are two types waterfall methods that are used in the
Industry, they are

1.european water fall method

2.american waterfall method

European waterfall method is MOST COMMONLY used method, this

is better for the investor.in this case the cash distribution should
be based on WHOLE of FUND numbers rather than investment by
investment numbers (deal by deal basis)

Ex: as explained above, if the investors invested rs100cr, fund

invested in to 2 companies, the fund should return all the principal
and pref return on all the investment(100cr) before they can take
carry.if they sell one investment fo rrs80cr e invest in 6th year,
made rs 30cr profit, still they cannot take carry since all the 100cr
is not yet paid to investors. If that is American waterfall method
they can take carry by selling one investment also if that investment
gave good return(deal by deal, deal means one investment).

American waterfall method is less used, more helpful to GP.in this

case, deal by deal the carry can be calculated and distributed to
GP.so, if they sell one investment in 4th year, GP may get carry if
that investment gave profit ex: if the fund invested rs100cr in CRED
and sold it for 150cr in 5th year, GP take carry on that profit. if
they invested rs 200cr on OYO rooms and sold for 190cr, they made
loss so they will not take carry on that. important advantage to GP in
this method is they can get carry much earlier like in 6th year or 7
year also but in European they have to wait for more time like in
9th/10th year only they can get that carry(generally)
23-03-2022

KEY TERMS

Hurdle rate:
This is the rate at which the GP has to generate the returns to get
ELIGIBILITY for the carried interest. this is not a guaranteed
return to the investors, if the GP achieved this return in a fund,
they are eligible to take carry. most common rate used in
international funds is 8% return per year

EX

:if sequoia capital raised 1000cr from investors, they can take the
carry only if the fund made profits of more than 8% per year.
assuming they managed the fund only for 1 year then the profits
should be more than rs80cr(1000*8%)

so from investor perspective, they can make some return like 4%

(countries like America) by investing in bank fixed deposits 2 or by
investing in bonds issued by government etc where the risk is almost
nil(risk free return).so, they add, risk premium of around 4% and
expect around 8% from these funds and they are ready to share the
profits if the return is more than 8% per year.

in India, most of the funds keep this rate at 10% per, there are two
types of hurdle rates in usage, they are

1.hard hurdle rate

2.soft hurdle rate

in hard hurdle rate, return up to that rate like 8% belongs to
investors and any excess profit can be shared e ex:if investors gave
rs100cr and the profit is 10cr, the distributions is as below assuming
hurdle rate 8%

Principal 100 crores To investors

Preferred return 8 crores To investors
Profit share –GP 0.4 crores To GP, 2cr *20%
Profit share – LP 1.6 Crores To LP, 2Cr*80%

in soft hurdle rate, the GP can share ALL the profits once the
return is above the hurdle rate. distributions is as below for the
above example

Principal 100 cr To investors

Profit share –GP 2 cr To GP, 10 cr*20%
Profit share – LP 8 cr To LP, 10cr*80%

Soft hurdle is better for the GP since they get more profits once
the returns are above the hurdle rate.

PREFERRED RETURN:

This is the amount calculated on investors investment in the fund by

using the HURDLE RATE.

EG:

Fund name - Sequoia India fund

Commitment - 1000 crores

Contributions - 100 cr in 2021, 100 crores in 2023

Hurdle rate - 10%

if the fund has more out standing principal, this preferred return
will be more.so, the fund manager generally calls money late/when
they really need the money and distribute the money to investors as
quickly as possible when the receive any cash like income/on sale of
investment so out standing principal/unreturned principal will go
down so the amount payable as preferred return also will go down.

where ever applicable, the GP will also use the bank loan/leverage to
make investments so they don't need to calculate preferred return
on that since it is not investor money. if the bank int is 2% and
hurdle rate is 8%, it is better to use the bank loan first.

Calculate the preferred return to the above example assuming the

below additional transaction.

1/1/2024 contribution to invest in OYO rooms is 300 crores

1/1/2025 contribution by investors for management fee 20 crores

1/1/2026 distribution from fund rs 50 crores by partial sale of

stake in OYO rooms.

1/1/2027 contribution by investors 300cr for Cred investors

( first 3 rows are from before table)

in this scenario as of 2027 end, the fund should generate atleast

1091.3cr to get any carried int income to GP ess since there is
principal outstanding of rs 770cr and pref return o/s of 321.27

Catch UP:
this provision/section in the waterfall model allow the GP to take the
remaining cash in the fund before they can share as the profits or
remaining cash in agreed ratio like 20:80

ex:

if the fund already paid principal and pref return to investors and
the balance cash is rs100cr,the gP will get 20 cr if ratio Is 20:80.if
there is a catch up clause in the LPA that allow the GP to take some
money as catch up and then go for profit share, he might take all
that 100cr as his share so the benefit will be more.

generally, this catch up is calculated as % on preferred return in

that fund. teh GP will ask the investors to pay some amount like 20%
on pref.return from the remaining cash (after principal and pref
return is paid) and then go for profit share.
so, GP is also happy since investors got their return in the name of
pref return and GP got his return in the name of catch up so they
can now share the remaining cash profits.

*(yt and google suggestion companies – light speed venture partners)

FUND NAME – BLACK STONE INDIA FUND

INVESTEMENT made by investors - 1000 crores

Vintage year - 2020

Pref. return as of 12/31/2025(usa date) – 900 crores

Pending investments to be sold are akash education, Byjus. calculate

the carried interest if they can sell both investments for 1950cr
and 2500cr if tehre is catch up of 20% and if there is no catch up.

if catch up is there, the GP can get all the remailing money up to rs

180cr in the above example

this money is not taken out from investors pref return of rs 900,
this is only taken if there is balance cash over and above the pref
return(if the cash available is 1900cr then 1000cr principal and
900cr pref return goes to investors only).
24-03-2022

If these two companies shares are sold for rs 2500 crores the
distribution will be as follows.

If catch is there if no catchup

Details Eligibility Paid Balance Paid balance

Principal 1000 1000 1500 1000 1500
Pref.return 900 900 600 900 600
Catchup 180 180 420 0
GP profit 84 120
share-
20%
LP profit 336 480
share-80%
CARRIED 84+180=264 120
intrest (600*20%)

*so due to catchup the extra carried interest in this cais s crores (
264cr in option 1 vs 120 in 2)

CLAWBACK:
This provision is waterfall provision allow the investors to
pullback/clawback any excess intresr paid to GP earlier.

Eg:

If GP took rs 1500 crores as carried interest and calculations

provide he is eligible only for rs 1000 cr, the investors can claw back
the excess 500 cr from GP.
This can happen due to different provisions in the waterfall iwhere
GP is paid carry based on profits on early exits/sale of investment in
the fund, late the fund made losses so carry already paid is proved
to be high.

Eg:

If the fund follows American waterfalls method they made profits

on first teo investments ( OYO and UNACADEMY), later they sold
remaining two investments profits, Gp look rs 100 cr carry after
selling all investments , the fund is nit able to return the principal
and prf. Return to investors so investors can claw back this is rs 100
cr. Already paid to GP(If the shortfall on principal and pref. return
is 500cr, still the can claw back only upto 100 cr from GP)

Carried interest/waterfall provisions that are favorable to GP’S:

Hurdle rate - no hurdle rate

If hurdle rate agreed the – soft hurdle rate- Since GP can get share

In all profits once the return is above 8%, if H.R is 8%.

Catch up – better have – generaly 20% or 25% on pref. return.

Waterfall method – American waterfall.

Favorable to investors / LP’s:

Hurdle rate - having the hurdle rate.

If hurdle rate agreed the - Hard hurdle rate.

Catch-up - no catchup is better

Water fall method - European method is better.

NOTE:

Generally, 20% on pref. return is considered as catchup . if the GP

want 20% share in overall profit, then they have to negotiate for
25% catchup on pref. return.

Eg:

On the catchup example, if the fund sold the remaining investments

for 10000 cr, if catchup is 20% vs 25%, the distributions will be as
below.

If catchup – 20% if catchup – 25%

Details Eligibilit Paid Balanc Paid Balanc

y e e
Principal 1000 1000 9100 1000 9000
Pref.retur 900 900 8100 900 8100
n
Catchup 180 180 7920 225(900*25% 7875
)
GP share 1584 1575
– 20%
LP share – 6336 6300
80%
1764(180+15 1800(225+157
84 5)

Sale proceeds – 10000

Cost - 1000

Profits -9000

If GP take 20%share- 1800

So if the catchup is 25% on pref. return. The GP will get 20% of
overall profit if they take 20% on pref return, they will get approx..
19.6% on overall profits.

TERMS RELATED TO INVESTORS CASHFLOW:

Dry powder: (google about it for better understanding)

This is the amount committed by investors to the fund or funds that

is yet to be called and invested by the fund manager.

Eg: total dry powder in the private equity industry is more then 2
trillion.

J CURVE:

NAME – dhoni

Committed – 100 cr

Vintage year – 2021

Year Rupees comments

2021 -10 Management fee
2022 -30 Invest in oyo
2023 -50 Invest in rapido
2024 -10 Invest in paytm,
management fee.

2025 2 Dividend
2026 4 Dividend
2027 50 Sale oyo
2028 50 Sale rapido partially
2029 70 Sale of rapido partial
2030 55 Sale of paytm
131

In the investors cash flows is presented on a graph, it will show like

J CURVE since there are outflows in initial years and inflows in later
years ( industry says investors in p/e funds should be ready for J
CURVE impact).
Journal Entries – Launched investors cash
flow :
Fund name – india reality excellence fund VLP

Sponsor / GP/ Fund house – motilal oswal group.

Commitments – 1200 cr

Investors – Amitabh , katrina , dhoni, saini

Investment – prestige marie gold, DLF office parks, sreeram

properties residential projects.

Vintage year – 2020

# Fund had started close in jan 2020, Amitabh and saina committed
rs 300 cr. Each.

NO ENTRY SINCE THERE IS NO CASH FLOW.

Fund made research and agreed with sreeram properties to invest rs

150cr. In one of the propert in Mumbai.

Called rs 75 crores each from both the investors.

CAPITAL CONTRIBUTION RECEIVEBLE A/C DR 150

TO CAPITAL /c 150

After 15 days , both the investors sent/paid the money.

BANK A/C DR 150

TO CAPITAL CONTRIBUTION RECEIVEBLES A/C 150

Invested that money into sreeram properties

INVESTMENT IN PROPERTIES A/C DR 150

TO BANK 150

For the first quarter fund is charging the below management fee
from investors, what is the ENTRY

Commitement - 600

Fee rate - 2%

Per year - 12

Per quarter - 3

MANAGEMENT FEE A/C DR 3

TO MANAGEMENT FEE PAYABLE A/C 3

(Expenses recorded in the management fee)

IF the fund distributed 5 cr from the rental income.

CAPITAL A/C DR 5

TO CAPITAL DISTRIBUTION PAYABLE A/C 5

when they actually paid , after 1 week

TO CAPITAL DISTRIBUTION PAYABLE A/C 5

To BANK A/C 5
25-03-2022

Investment strategies:
at the time of launch of fund, the fund manager/fund house has to
inform the investors about the investment strategy/investment
objectives of the fund. Based on this, the investors can understand
where the fund will invest the money, that will be find the risk in the
fund.

Ex:

if a mutual fund says the money will be invested in equity shares of

companies, that is more risky than a fund investing money in debt
securities like debentures and bonds. with in equity funds/schemes,
if a fund says it is large cap fund, they will invest in to shares of top
companies like reliance, TCS, Infosys etc so risk is less compared to
small cap fund where the money is invested in small companies like
just dial, prince pipes.

to give better returns to the investors and to diversify their risk,

these fund managers will come up with new investment
ideas/investment strategies form time to time. each mutual
fund/Private equity fund/hedge fund can be different in is their
strategy/approach to manage the fund.

these p/e and hedge funds has no restriction/limited restriction on

where they can invest so they use more variety of strategies, some
of them are.

➢ venture capital strategy

➢ real estate
➢ infrastructure
➢ PIPE-private investment in public equity
 ➢ venture capital strategy
➢ credit
➢ mezzanine
➢ LBO(Leveraged buy out)
➢ fund of funds
➢ pre IPO
➢ distressed strategy

Fund Of funds:

in this case one fund will invest in to other fund/funds rather than
directly investing in to company/asset.

ex: if Navi company launches an international fund of fund in India,

they will invest in to a fund launched by JP Morgan or goldman sachs
in America. (one or more funds they can invest) this is popular
strategy in MF/PE/HFs due to below reasons:

1.more diversification-

each main fund will invest in to one or more underlying funds, these
underlying funds will invest in to more stocks/assets so number of
investments that a fund invested is more so risk is diversified (one
or two portfolio companies are failed, no major risk to investors).

2.use the expertise of diff.asset managers-

if goldman sachs launches a fund, they can invest in to black stone

funds for real estate, KKR funds for buy out etc. since these
companies are specialized in the investments in to these categories
it is good to use their expertise
Main fund Underlying fund Portfolio companies
Navi Nasdaq fund Jp morgan bluechip *apple
fund *Microsoft
*Facebook etc.

Venture capital strategy

in this strategy these venture capital or private equity funds invest
in to start up companies.

Star up means a company having a innovative business idea and it is

newly started e since the business model is not tested earlier, it is
difficult to predict the success or failure of the business So this
strategy is risky and investors who aim for huge returns and ready
to take that extra risk can invest in these funds related to funding
of startup’s , the common hierarchy of funding is as below.

Real estate:
in this case the fund will invest in to real estate assets like office
parks (software parks etc), hotels, shopping malls, warehouses etc

income to the fund is rental income and appreciation in property

value.
if the income of the property is rs 5cr per year, if that is increased
to rs 10 cr in the next year, value of the property will increase by
100% and the fund can sell that property to other fund/investor.

common % of income in real estate properties is 5% which means if a

property can get 5L rent, value is assumed to be 1crore.

to get the better rental income, these fund managers use the
services of asset mangers (firms like JLL, CBRE) who will 6 help to
get the tenants who can stay longer and they also help to negotiate
the rent terms.(these asset managers fee it is recurring fee, it is
charged in the fund books)

these funds also appoint property managers who will keep the assets
in good condition, they take care of maintenance, facilities in the
property are good etc

depends on the risk taking ability of investors and strategy of the

fund manager, they can invest in commercial real a estate like
shopping malls (risk is less), residential real estate like apartments
(risk is more to sell in time etc).

REIT concept-Real estate investment Trust:

one of the strategy/way to exit from the investment is issue REITs

to the public.

ex:

if black stone invested in office parks rs 5000cr,they want to sell.

they may not find a real estate buyer or a company easily. now they
can transfer these assets to a trust, that trust will convert this
asset in to 500cr units at rs 10 per unit.
these units will be sold to public in IPO process, these units/shares
will be listed in stock exchange like BSE/NSE retail investors can
buy and sell them in the exchanges. these retails investors get the
dividend from the rental income, the unit/s hare price will increase
in the market if the real estate price goes up or rental income of
the property increases.

28-03-2022

Infrastructure Strategy:

these funds invest in infra assets like roads, airports, sea ports etc
and make income from toll charges, user charges

etc. they also make profits on appreciation in the value of these

assets. if the income from that asset is doubled, property value is
also assumed to be doubled.

ex:if toll charges from one road asset is rs 100cr this year, that
property value is assumed as 1000cr.if the income increased to rs
200cr, property value is assumed to be 2000cr.this appreciation in
the value is recorded as gain in the books of that fund.

INVIT:
this concept is about converting an infrastructure asset in to
securities and sell to public. if a p/e fund or any company like
reliance jio owns infra assets like highways/airports/telecom
towers/internet cable etc, they can convert that in to s securities
(form a trust and transfer the assets to trust, that trust will issue
units to public and list these units in stock exchange like bse) and
sell to public.

reliance JIO, NHAI etc are also using this route to sell the infra
assets.

LEVERRAGE BUYOUT:
in this case the fund will buyout an existing company mainly with help
of borrowed capital(leverage). they can make more profit if the gain
is more than the interest cost.

Ex:

if the fund takes 1000cr from investors, borrow 4000cr and invest
all 5000cr in a company and sell it for 8000cr, they made 3000cr
profit, profit of 60 % (3000/5000*100) on investment for the
investors it is 3000cr profit on 1000cr investment so 300% return.
assuming int cost is 10% (400cr int cost on 4000 cr borrowed
capital), still the profit is 2600 cr(8000 sale price-5000cr
investment-400cr int cost) so return is 260%.

PIPE-private investment in public equity:

in this fund invest in public company like reliance, Bajaj finance etc

Credit strategy: invest in bonds and get interest income, less risky
than venture capital etc.
Mezzanine:

invest in convertible debentures, warrants etc where the fund will

get interest/fixed income for some time like 5 years, later, these
will be converted in to shares so the fund can also get appreciation
from shares (on conversion/ later. if the fund gave 100cr, if the
company issue 1cr shares on conversion, if share price is 150,value is
150cr so con conversion also they can make profit).

Distressed strategy:

in this case the fund will invest in loss making/troubled company or

asset so they can buy them at cheaper valuations and make profit by
selling at profit.

Fund name - Godrej realty Fund

Investors - Allianz,Amitabh, Kohli

Commitments - 4000cr

Investments - Godrej One, Forum Mall

Vintage Year - 2019

in 2019 June, they decided to invest in forum shopping mall rs

1000cr, journal entries are as below

CAPITAL CONTRIBUTION RECEIVEBLE A/C DR 1000

TO CAPITAL A/C 1000

(capital call notice sent to all investors)

Money received from investors

BANK A/C DR 1000

TO CAPITAL CONTRIBUTION RECEIVEBLE A/C 1000

Made investment into godrej building

INVESTEMENT IN REAL ESTATE A/C DR 1000

TO BANK 1000

( After 3 months, fund is preparing financials , so they have to find

out market vale)

Find finalized value rs 1200 crores

INVESTEMENT IN REAL ESTATE A/C DR 200

TO UNREALISED GAIN/LOSS ON INVESTMENT A/C 200

After 1 year, they sold this investment at rs1100 crores reverse the
unrealized gain/loss so value will come down to original cost.

TO UNREALISED GAIN/LOSS ON INVESTMENT A/C DR 200

TO INVESTEMENT IN REAL ESTATE A/C 200

Now post the entry for sale and any gain/loss (realized)

BANK A/C DR 1100

TO INVESTMENT IN REAL ESTATE A/C 1000

TO REALISED GAIN/LOSS ON INVESTMENT A/C 100

29-03-2022

Q.how frequently these funds prepare the financial

statements/NAV?

mutual funds - daily(since the retail investors can

enter/exit the fund any time)

P/e funds - generally quarterly/monthly

H/F(hedge fund) - generally monthly

at the time of launch, they agree this based on investment type

(liquid/illiquid), finalise the frequency like monthly/quarterly and
mention that in LPA.

they prepare unaudited financials on quarterly basis(generally) and

audited financials on yearly basis.

Q.how these financials are prepared like Indian GAAP/US

GAAP/IFRS etc?

depends on the registration of the fund. if registered in US, they

follow US GAAP(most common since most of the funds are
registered in America)

other Generally accepted accounting principles (GAAP) that are

popular are IFRS(international financial reporting standard),
Luxembourg GAAP Etc.

if master is in USA, they prepare based on US GAAP and if feeder

is in Luxembourg, they use Luxembourg(LUX) Gaap for feeder books
preparation. separate audit will be done for both these funds and
then sent to investors.
Q.if you are an investor in feeder, you will get master financials
or feeder financials?

Genreally, both the finnacial statamnets.

feeder generally collect money from investor and invest in master

fund.so, in the feeder books, only one investment 95 can be
reported, that will not explain the risk in the fund(risk from the
investment where the fund's money is invested) So, they will send
feeder financials and master financials so investor can understand
the risk based on investments reported in the master (if they
invested in loss making company, risk is more etc).

Q : what are the contents in financial statements that are sent

to investors?

1 statement of assets and liabilities - SOA

2 statement of operations - SOI

3 schedule of investments - SOC

4 Statement of changes in partners capital

5 cash flow statement

6 notes to accounts

Q: who are the parties involved in the finalization of financial

statements of funds?

1. fund administrator-like state street /bny mellon/citco/apex who

will record all transaction in the fund and send the TB, Financial
statements for review.
2.Fund house like Goldman sachs/blackstone who review the financial
statements and send them to investors

3.Auditors like KPMG/deloitte who audit the financials and issue

audit report (during year end) at fund admin level, they coordinate
with other parties and complete the reconciliations etc

EG: if fund admin is state street, they will reconcile all the data like
number of shares owned by the fund etc with custodian records and
prime broker records (prime broker helps the fund to purchases the
shares in market).

Q. what is NAV cycle/sequence of activities) to finalise NAV of

a fund?

1. post all bank payments and receipts

2. post all adjustment entries like fee payable, valuation

increase/decrease in investments tec

3.review general ledgers and close th GLs

4 review Trial balance(TB) prepare schedules for management fee,

carry, accruals etc

5 send the monthly pack/quarterly pack for review (fund admin

prepares all TB and schedules and sent to fund house for review)

6 once TB is approved, prepare allocation file(allocating fund level

income and expense to each investor so capital statement can be
prepared)

7 once TB and allocation is approved, they prepare the balance

sheet, all financial statements

8 after review of all financial statements including notes, they will

send to investors. if year end, auditors also review all financial
statements and provide audit report, that audited set will be sent to
investors and regulators etc (fund house like blackstone will send to
investors, not fund admins)

30-03-2022

Fund name

Journal entries for the period 1.1.2022 to 3.31.2022

Journal entries for the period 1.1.2022 to 3.31.2022

fund name - Blackstone growth fund

Investors- canadian pension fund, new York pension fund

Commitment -30000 cr

Investments - embassy, akash education

Fund had first and final close on 1.1.2022 for 30K crores, 2
investors came in to the fund

no entry

assuming no investments are made in Q1 2022 (jan to march) no

entries related cash/bank all accrual entries for income and expense
to be posted.

no income since no investments are made.

all below recurring expenses to be posted

Commitment - 30000 crores

fee base - commitments

fee rate - 2%
fee till 31 st march = 147.95 (30000*2%*90/365)

Management fee a/c dr 147.95

to management fee payable a/c 147.95

other professional fees are acrued

audit fee dr 0.1

Custodian fee dr 0.2

fund administrator fee dr 0.4

tax consultant fee dr 0.2

RTA fee dr 0.1

to audit fee payable .1

to custodian fee payable .2

to fund administrator payable .4

to tax consultant fee payable 0.2

to RTA fee payable 0.1

PTO
(all expenses accrued for Q1 2022)

NOTE: this net asset of -148.95 is capital balance of investors since

loss is allocated to them it will be NEGATIVE.

In that case , asset and liab will become 0 in Q1 2022( asset 0 , liab
148.95 so net 0)

Capital and reserves

Capital 0

reserves/accumulated profits/losses -148.95

Q1 gain/loss transferred to partners -148.95

total capital -148.95

Statement of operations (p/l a/c) of Blackstone growth fund for the
period ended 31.03.2022

DETAILS RS
Interested income 0
Dividend income 0
Other income 0
Investement income 0

Management fess 147.95

other expenses 1
Due diligence 0
Total expenses 148.95
NET INVESTEMENT INCOME (0-148.95) -148.95

Unrealized gain/loss investments 0

Realized gain/loss from investments 0
Unrealized gain/loss from FX(foreign exchange) 0
transactions
realized gain/loss from FX(foreign exchange) 0
transactions
NET GAIN/LOSS -148.95

Journal entries of Q2 2022(Apr to June 2022)

the fund decided to invest rs 5000cr in Byjus

for that we have to call the money from investors

CAPITAL CONTRIBUTION RECEIVEBLE A/C DR 5000

To CAPITAL A/C 5000

(Capital called from investors )

BANK A/C DR 5000

TO CAPITAL CONTRIBUTION RECEIVEBLE A/C DR 5000

(Money received from investors)

INVESTED IN COMPANY THAT 5000 CR

INVESTMENT IN SHARES A/C DR 5000

TO BANK A/C 5000

(being investment made)’

As on of 30th June , this investment is valued at rs 6000 cr

INVESTMENT IN SHARES A/C DR 5000

TO UNREALISED GAIN/ LOSS A/C 5000

All expenses like management fees, audit fees will repeat in

every quarter.

This American fund invested in rs (5000 cr) market value is 6000 cr.
They invested 1 USD is rs 70 and now its rs 78 gain/loss to be
reduced.

If USD 70 RS IF USD 78RS

Sale proceeds if sale @ 6000 85.71(6000/70rs) 76.92(6000/78)
cr
Loss due to appropriate in
USD(DEPRECIATION IN INR)

Fund is receiving only 76.92 rather then 85.71 so loss of (85.71-

76.92) = 8.79 crores
UNREALISED LOSS ON FX TRANSACTION A/C DR 8.79

INVESTMENT IN SHARES A/C DR 8.79

(loss on currency is recorded)

(Note: only entry is recorded for an Idea, since we are reporting the
numbers in INR, this is not reported in the 2075 balance sheet or in
income statement now. if all numbers are converted to USD then
this gain/loss also to be reported)

assume the fund has agreement to pay management fee and

audit fee each quarter, they will call the money and pay to them

Q1 Management fee 147.95

Q2 Management fee 0.1

Total amount called from investors

In Q2 148.05

CAPITAL CONTRIBUTION RECEIVEBLE A/C DR 148.05

TO CAPITAL A/C 148.05

When received that money

BANK A/C DR 148.05

CAPITAL CONTRIBUTION RECEIVEBLE A/C 148.05

Expenses accrued are now paid

MANAGEMENT FEE PAYABLE A/C DR 147.95

AUDIT FEE PAYABLE A/C DR 0.1

TO BANK A/C 148.05

Balance sheet as (statement of assets and liab) as of 6.30.2022

DETAILS RS
ASSET
Investments 6000
Cash at bank 0
Contribution receivable 0
Interest receivable/ dividend receibles 0
TOTAL ASSET 6000
LIABILITIES
Management fee payable 147.95(Q1
PAID, Q2
ACCRUAL
IS
PENDING)
Accrued exp and liab 1.9
Distributions payable 0
TOTAL LIABILITIES 149.85

NET ASSET(6000-149.85) 5850.15

CAPITAL AND RESERVES:

CAPITAL 5148.05(Investment in management

fees and audit fee of Q1)

RESERVES AND SURPLUS 702.1 (Q1 gain / loss transfer to

partnership)

Total capital 5850.15

Statement of operation (P&L A/C) of Blackstone growth fund for

the period 1.1.2022 to 6.30.2022
partner Capital statements (P-caps) are prepared for each investor
and send to only that investor. this will help each investor to
understand the fund performance and his/her NAV as on that date.

Ex:

if Priyanka invested rs 1000cr in the fund, NAV is 1200 cr, she made
rs 200profit in that fund based on her NAV in cap statement she
can understand the performance of the fund, they can compare
these cap statement numbers with fund level numbers in financial
statements.
below is the capital statement of canadian pension fund who has 50%
ownership in the fund. Capital statement of CANADIAN PENSION
FUND as of 6.30.2022.

Capital statement of CANADIAN FUND as of 6.30.2022

Particulars Rs
op balance 0
Interest income 0
Dividend income 0
Management fees 147.95( exp. 50% of total fee
allocated to this investor)
Professional fee 1
Unrealized gain/loss 500
Profit/loss for the current 351.05
period
Capital contribution 2574.03
Closing balance/NAV 2925.075

History to date(HTD) balances

Commitement 15000
Contribution
25474.03(investment+management
fee+audit fee of Q1 from
inception of the fund)
Distribution
0
Unfunded commitement
12,425.98

TOTAL ESTIMATED VALUE

Distribution
0
Nav
2925.08
TEV
2925.08(NAV+ DISTRIBUTION
made from inception)
Contributions made
2574.03
MOIC(multiple on invested
1.4(TEV/CONTRIBUTION)-
capital)
2925.08/2574.08
ALLOCATION OF P/E
FUNDS(ALSO IN HEDGE
FUNDS)

To prepare the capital statement of each partner, the fund admin

need the finalized numbers of each partner in the fund so this
allocation file is prepared.in this process, all expenses and income of
the fund is allocated to each partner in their ownership ratio.
however, there are some exceptions to be noted in this case, like.’

1.GP, CIP, Employees of the fund house etc will not pay any
management fee, carried interest so they should not be allocated
that expense(carried interest partner(CIP) is at times registered in
a fund to receive carry income)

2.discounted fee investors-some investors in the fund may pay less

fee like 1.5% when all other investors pay 2% so we have to calculate
their numbers separately and allocate their portion of fee rather
than allocating it based on their ownership.

3. partner transfers-one investor may be transferred the stake to

another investor in between the accounting period like on 30th 15
jun.to allocate that year expenses, we have to keep 50% allocation to
partner A and balance to new partner. If there is int expense in the
fund on loan taken from july 2022, that should be allocated to only
new partner and not 50% each to old and new partner since this
expense is incurred in 2nd half of the year.

few terms related to financial reporting:

escrow account:

this is the cash in restricted account for the fund.

Ex: if the fund sold an investment for rs 1000cr,buy might pay

950cr immediately nd deposit rs 50 cr in separate bank account,
fund can use that money only after fulfilling some conditions after a
period like 6 months. Govt enments also keep like this to release
money to road contractor etc after 3 months by ensuring there is no
damage to the roads completed by that contractor.

managemnet offset: at times, at the direction of the the GP, funds

may offset/reduce the management fee in a fund ex: fund life
timgis 10 years but extended 2 more years since the investments
are not sold so GP may not charge fee for these 2 yrs Or the fund
got some additional income like placement fee (fee paid by another
fund house to this fund for placing investors money in that fund,
assume you have invested in KKR fund, they invested that money in
JPM fund, JPM pays placement fee to KKR) so that fund(KKR)
reduces the fee to the extent of that additional revenue.

broken deal/dead de deal: means a fund making investment in to a

company/asset.some times these investments are failed in last
minute due to failed negotiations on price etc. all the cost incurred
till that time is considered as broken deal cost and accounted as
expense in the fund.
Ex: KKr team travelled to India, met Byjus team to negotiate on
valuations to make investment. they have incurred rs 10cr finally
they decided not to invest so accounted that 10cr as broken deal
cost(if success, this cost is included in cost of investment).

DUE DELIGENCE:

due diligence cost before taking any major stake in a company, these
funds conduct extensive research like understand the 118 financials
of that company, discuss all potential risks for that business
including any court cases pending on that company etc, this is due
diligence.

Valuation hierarchy/fair value hierarchy in P/e or hedge funds or

mutual funds

most of these funds(mainly p/e funds) invest in to illiquid

assets/assets having no active market) so knowing the market value
of these assets is not easy.

these funds has to know the market value of the assets in the below
scenarios/times

1.when the fund is investing/buying the asset

2. when the asset is sold/exit time

3.to prepare the financial statements/finalize the NAV(net asset

value) of the fund

to know the market value of an asset, there are various sources,

each source has different risk to that number/valuation.

Ex : if the market value of Infosys shares is reported using the

traded price of that share in NSE/any stock exchange the risk is
less, same/similar value can be received by the fund by selling that
asset in market tomorrow/that day. if the fund invested rs 1000cr
in a shopping mall/start up company etc and reported the market
value as rs 1500 cr based on their calculations since there is no
active market to that asset, risk is more, the fund may get only
rs.500cr tomorrow when they actually sell.

To highlight these risks, these funds has to report the sources for
market values in the financial statements (US GAAP/IFRS/any s
other gaap).so investors can understand if the profit/loss reported
in the fund and NAV reported in reliable or subject to major
changes.

All these valuation sources are grouped in to 3 categories and

reported in the financials.

1.Level 1- market value of the investments are considered as rs

1000cr, these values are based on the price in active market like
stock exchange, commodity exchange etc. since this price is derived
in the market based on thousands of participants, reliability is more
if the fund want to sell these assets tomorrow they will get rs
1000cr or near to that.

Ex: share’s of listed companies like apple, reliance, commodities like

Gold etc comes in this category .

2. Level 2-market value of investments is rs 500cr in thie level, the

source is one of the below

a. based on similar asset value in active market

ex: fund invested in flipkart shares which are not traded in market
but similar company like amazon is trading, based on change in
amazon market price, this fund can calculate the market value of
flipkart shares
B.based on similar asset market value in other than active market.

ex.: fund invested in a shopping mall in Bangalore, similar shopping

mall is sold by somebody for 20% appreciation in this month
compared to its vales a month back so same 20% appreciation applied
to this shopping mall owned by this fund etc

Level 3-fund valued the investments based on their assumptions

etc.

Ex black stone fund reported total market value of all investments

as rs 10000cr, level 3 investments are 2000cr.these are investment

in start ups like Byjus, Rapido bike etc. since these shares or similar
company shares are not traded in market, fund calculated the
market value based on projection of revenue Of these companies.
using DCF(discounted cash flow method), they have projected the
revenues of the company for future years and valued company at
rs500 cr or rs 50 per share. earlier this share is reported at rs
40,now they have reported profit of rs 10 per share based on this
projections.

If a fund reported more investments in level 3, risk is more so they

have to give more additional details to investors like the source for
these calculations if they used discounted rate of 10%, how they
decided/factors influencing that etc).
DISCOUNTED METHOD:

Discounted cash flow method:

Financial highlights:

all funds (MF/HF/PE) need to report certain financial highlights in

the books(financial statements) so investors can 2 compare two diff
funds. commonly reported FIHIs(financial highlights are).
Equliasation and rebalancing:

accepting new partners in to p/e funds are common, they accept the
investors when they have 2nd close, 3rd close etc Ex: fund launched
in 2022 jan, there are A, B in the fund, they have 50% ownership
each . if the fund continues with only these partners, they will get
50% profits are losses through out the life time like 10 years if the
fund bring new partners as c and d in 2023, future profits will be
shares between all of them in new profit sharing ratio like 25% each
so, fund has to allocate old profits or losses to all the partners so all
are equal now

ex: fund made rs 100cr loss due to accrued expenses (there are no
contributions/investments in 1st year) in the 1st year ,earlier, that
was allocated to all partners 50% each. now they will
reallocate(rebalance), by reducing allocation to old partners and
allocate that to new partners so all of them will have 25cr allocated.
in the future all gain/loss or contribution etc will happen as 25%
each to all these partners(or based on their ownership ratio)

Equalization requires the below conditions:

1.The fund has more than 1 close

2.old partners already contributed some money so they are

expecting some extra return for their contribution Generally, these
PE funds pay some interest like 8% or LIBOR+4% as return to the
old investors for the excess contribution made by them on behalf of
new investors before the joining of new investors

Ex:

1-4-2022

Fund accounting industry

Common terms etc

q. differences between open ended and closed ended fund?

interval funds-

not much popular, these funds work like closed ended for most part
of the year but kept as open appx 10 days in year/6 months.

ex: if hdfc launches an interval fund in 2020 with 10 years life time,
each year from 1st july to 10th july, the fund will keep it open where
old investors can give units back to fund and take money to exit
from the fund, new investors can also buy the units from the fund
house(hdfc) in these 10 days. all remaining days, fund is closed so no
issue of new units or redemption of old units. Note-in case of mutual
funds, to provide liquidity to retail investors, these closed ended
funds are listed in a stock exchange so an old investor can sell and
new investor can buy the units directly in stock exchange between
them. fund house like hdfc do not involve in this case.

Note: if mutual funds are closed ended, they list the units of the
fund in stock exchange so investors can buy and sell between them
(fund manager will not pay the money, inv can Ito others in
exchange).if P/e or hedge fund is closed ended, they will not list
since investors not required that option/liquidity.

Regulatory reporting:

to ensure the investors money is not missused or the fund houses

are properly managing the investor's money and are properly made
on all risks in the fund etc., there are regulatory bodies like
SEBI(Securities exchange board of India), SEC (Securities
exchange commission) etc.

ex :

to control banking system like who can do bank business, how much
amount they can give loan/eligibility criteria etc, the se regulator in
India is Reserve bank of India (RBI).

these regulators will decide on who can launch these funds (like
SBI,HDFC etc has licence in India), rules they have to follow to
ensure the investors money is not mis used.

ex :
these fund house should appoint a custodian for each fund who will
keep the assets of the fund like Gold/shares etc in their
custody/control.

These fund manager/GP etc cannot charge their personal expenses

in the fund or they cannot invest in more risky securities with out
mentioning it in inv objective of the fund /legal documents like PPM
etc

these funds should submit many reports like financial statements on

a quarterly/monthly basis and specific forms to these regulators and
they will examine these and they can impose penalties or they can
cancel the license of these fund managers/ fund house if it is proved
that the fund is not managed as per the legal docs like PPM etc some
of the regulations to be noted/applicable are

RDR,MIFID1,MIFID2,AIFMD,VOLKER RULE, INSIDER TRADING

RULES etc.

Retail investors:

Salaries employees , students etc who can invest less money and
they can take less risk, mutual funds, equity shares, bonds etc. are
preferred investments for them.

Institutional Investor:

institutions like provident funds, pension funds etc who can invest
more money and they can take more risk They Are registered with
regulator like SEBI to participate in IPOs, to invest in market etc.
SWF-sovereign wealth funds:

these are funds owned by governments like govt of Dubai, Singapore

etc who can invest huge amounts like 100s of crores to lakhs of
crores.

HNIs-high networth Individuals:

Individuals with net worth of more than 1 million dollars/7.5cr

rupees who can invest in lakhs/crores and ready to take risk.

Alternative Investmnets:

any investments in to other than traditional investments like

investment in shares, bonds etc are called as alternative
investments.

Ex: Investment in Gold, real estate, Private equity funds, hedge

funds, wine, vintage cars, arts etc .Funds dealing with these
alternative investments are called as alternative investment funds

ex: the below classification is generally used in the industry.

Category Example

AIF 1 Venture capital funds

AIF 2 Private equity Funds

AIF 3 Hedge funds

04-04-2022

Assets under management (AUM):

if a fund house like SBI says their AUM is 6 lac crores, they are
managing that money on behalf of investors. this is used in the
industry to know which is the biggest fund house or what is the total
money invested in to funds in a country etc

ex: AUM of black rock is more than 500 lacs crores (in rupees),
India AUM(mutual fund Industry) is 37 lac crores.

Top 4 fund houses by AUM in India are, SBI AMC, HDFC AMC,
ICICI AMC, Aditya Birla AMC worldwide top fund houses are
Blackrock, Vanguard, fidelity, State street, JPM Etc

to calculate the AUM, industry practice is to consider the assets on

which they are earning fees(mgt fee/incentive fee) sex: if state
street has foo mutual funds, NAV of all those funds is 100 crores
then AUM is 100cr if the fee is charged on NAV

if they have 50 PE funds, total commitments of those funds is 5000

cr, then AUM is also 5000Cr if fee charged on commitment.

Assets under custody (AUC)

custodian keeps the assets of the fund (like share certificates) in
their custody so investors money will not be misused by the fund
houses.

Ex: IF GS launches a fund, they will appoint Bny mellon as custodian

and pay custodian fees to them from the fund's money to count the
top custodians in the world, they use this AUC.

Assets Under administration(AUA):

A Fund administrator is responsible to take care of admin activities

of the fund like preparation of financials etc , these admins are paid
admin fees from funds money. NAV of each fund is considered as
AUA of that fund admin if they charge admin fee on NAV.

top fund admins are-SS&C global, CITCO, state street, Inter trust
etc

NAV-Net asset value

NAV-assets-liabilities of the fund

Nav per unit = NAV of the fund /no.of units in the fund

as all funds calculate this NAV so the investor knows the value of
his/her investment in the fund.

ex: amitabj invested in a mutual fund at rs10 per units in the last
year, today the net asset value per unit is rs 20 which means he
made 100% profit on the investment

This will increase if the fund make profits or reduce the expenses.
this NAV is used to settle the transactions of the investors like
subscriptions(entry of investor in to fund), redemptions (exit of
investor from the fund)

Ex: if NAV is rs 20 per unit today. You want to buy 100 units, the
fund will collect rs 100*20 = 2000

in case of mutual funds the und houses report the NAV per unit
since the retail investors can buy and sell in units and they can
redeem partial investment etc (if you have 10000 units, you may sell
only 100 units today).

in p/e and h/f, they report NAV (closing balance) of each individual
investor in P’caps (partner capital statements) so they can use that
number to know profits/transfer to other investor etc

These NAV calculations can go wrong for various reasons like

1. any investment activity is not recorded in time or recorded

incorrectly like purchased 100 shares, recorded 10shares.

2. missed to record an income like dividend, rent, unrealized gain etc

in time.

3. not able to process the corporate action in time like a company

declared dividend or bonus shares etc, fund not processed it in the
books in time.

4. investor activities/capital activities like

subscriptions/redemptions are incorrectly accounted.

To ensure the NAV calculations are correct and there Is no

miscommunication between the intermediaries like prime brokers (
who buy and sell the securities for the fund) , custodian , fund
administrator, fund house etc. there are many reconciliations like
cash reconciliation(ensure all cash balances of the fund is correct),
position reconciliation (ensure number of stocks/assets reported
incorrect) etc.

Hedge funds
hedge funds are like aggressive or advanced version of mutual funds.
these funds are also mostly open ended funds, pool the money from
wealthy investors and invest in to liquid assets(major portion) like
shares of listed companies, derivative contracts like futures and
options on stocks/commodities/currencies etc.

these funds generally target to make profits in short term like if

they know a company is announcing results or a merger kind of
announcement in near term and expected the stock to go up, buy
that stock more. if they want to take major stake, use derivatives
more since derivatives allow more leverage.

ex: hedge fund manager felt the reliance stock will go up by 10% in
next week, they want to invest 10000cr, they have 2000cr cash so
they can use derivatives like futures contract where they need to
pay only 2000cr(20%) to buy contracts worth 10K cr. advantage is if
the stock goes up by 10%, profit is 1000cr(10K cr*10%) though they
have invested only 2000 cr, so 50% profit (1000/2000*100)

if they made loss of 20% on investment, the loss will be 2000cr so

they will incur 100% loss of capital since they have only 2000cr,given
that as margin or advance and the loss is 2000cr so they lost all of
that money.
# when mutual funds were taking only long positions (buy today and
sell later), they can incur loss when market goes down which is
common due to economy slowdown etc.so these hedge funds started
taking long positions or short positions or combination like invest
50% money to buy stocks and 50% to sell stocks so they have
HEDGED their position. if market falls, short position/stocks sold
will give profit(Sell today at rs 100 and buy tomorrow at rs 50 so
profit of rs 50), if market goes up make profit from long position
ass (buy today at rs 100 and sell later at rs 150 when price went up
so profit of rs 50).So these hedge funds target "Absolute return"(
irrespective of the market, target profits).

# These funds also generally launch as open ended funds so they

allow investors to invest or exit any time. however, generally, they
keep restrictions like investor can only sell the units/shares in the
fund and get money by giving advance intimation like 1 month in
advance to with draw money, or sell only 20% stake in one year etc.
these restrictions on investors transactions are called as "Gates"

Generally they invest more money in to liquid securities like shares

of listed companies etc so they can easily buy or sell based on se
market situations to make profit or they can arrange money to
investors if investor want to exit. but some funds invest in shares of
start up companies etc

Depending on the strategy of the fund, fund can be open ended or

closed ended fund. Generally these funds are also registered as
limited partnerships(Lps) where investors are called as Limited
partners and the fund manager as General partner.

Like P/e funds, these funds also pay incentive fee like 20% to
GP/Fund house if the fund generates good returns to the investors.
to give more returns to investors, they follow different strategies
some of them are unique to hedge funds, those are

Long/Short strategy

Quantitative strategy

short only strategy

macro strategy

fund of funds

arbitrage (merger arbitrage/convertible arbitrage etc) strategy

Long short/strategy:
in this strategy the hedge fund manager buy the undervalued
(cheaper) stock and sell the overvalued (costlier) stocks.

if they have 10cr, they can use 6cr to buy and 4 cr to sell etc.

advantage is even if the market falls, they can make return from
stocks that are sold (short position).if market goes up, they can
make profit from long position(Stocks purchased)

ex: if Infosys is considered to be undervalued buy at rs 1500, sell at

rs 1800 once price goes up. if TCS is considered over values, sell at
rs4000 and buy at 3500 later and make rs 500 profit.

macro strategy:
in this strategy the fund manager will predict the macro economic
indicators like inflation, interest rates, GDP growth, geo political
issues etc to predict the market movement and prices of different
assets and then take buy/sell positions.

Ex: IF interest rates are expected to increase in USA, American

investors will sell their investments in India and take that money
back to America since they can repay the loans taken at low
cost/invest that money for better interest there. this will increase
the dollar value from rs 72 to rs 75 per dollar. these fund managers
can buy US dollars and sell INR/ Indian rupee.

To predict when the interest rates will increase in a country they

can follow or predict the inflation in that country, if inflation is
increasing, to control the inflation, central bank like RBI increases
the interest rates. if interest rates goes up, stock markets goes
down since many companies cost of borrowing (if loans are there or
planned to borrow) will increase So they may not expand the
business, also existing business will go down since customers not able
to borrow and buy more products (like homes, cars, two wheelers,
fridges Etc).

Quantitative strategy/Quant strategy:

in this case the fund will use lot of data to analyze and predict the
market and invest.

they use statistical models and computers to analyze the huge

amount of data and make a prediction on the price 4 movements.
computers will take the main part to take decisions and implement
the trades (also trading/algorithmic trading) renaissance fund
house, d.e shaw etc follow this strategy more.
arbitrage strategies:
arbitrage means out the price inefficiencies or price differences in
two markets and make profit from that.

Ex:

if a commodity /stock is at rs 100 in one market and rs 102 in other

market, buy at 100 and sell at 102.

This can be implemented in two different markets like BSE vs NSE

or between two securities in the same company etc exif you hold a
debenture of reliance which is purchased at rs 2000, that is
convertible debenture that can be converted in to one share of same
company in next month, that share is trading at rs 2100 then this
debenture is undervalues. you can buy that at rs 2000, convert in to
shares at rs 2100 and made rs 100 gain(convertible arbitrage
strategy) fund of funds strategy-similar to mutual funds, p/e funds,
in this case one hedge fund will invest the money in to one or more
other hedge funds.

Incentive fee/performance fee:

similar to p/e funds, these h/fs also has incentive fee provisions in
LPA which means the GP/fund manager will get the incentive fee if
the performance of the fund is good (generally if it is more than 8%
per year, 8% is hurdle rate) however, these funds need not have
waterfall provisions since they generally invest in liquid securities
and also allow the investors to invest/exit any time.so, they can have
this incentive fee paid to GP in frequent intervals.

# generally, they keep this time interval to settle the incentive fee
as 6 months which means on 30th jun and 31st dec of each year,
they can settle the incentive fee and pay to GP if there are profits
In the fund. this time is called as "crystalisation time/crystalisation
period"

ex: JP hedge funds started o 1/1/22 where each unit/share is sold

to investors at rs 100.if the value of each unit is rs 150 by 30th
june, there is a profit os rs 50 or 50% so the GP can take 20% of
that rs 50 which is rs 10 as incentive.

in the above case, rs150 is called GAV(gross asset value" or GNAV

)gross net asset value), that is the value per unit/share before
deducting the incentive fee

GAV/GNAV=NAV+ incentive fee

NAV per unit/ share is rs 140 in the above example

NAV=GAV-incentive fee

since these accounts are settled in frequent intervals like each 6

months/12 months etc, the value per unit(gav) will also change, each
time the fund made profit, fund cannot charge the incentive fee on
same profit more than once to ensure, this, they follow high
watermark concept.

DATE VALUE P.U

1/1/2022 100
6/30/2022 150
12/31/2022 120
6/30/2023 150

in this case the fund can charge incentive fee at 6/30/2022 since
there is profit and they cannot charge as of 2/31/22 since there is
loss(150-120=30 loss).as of 6/30/2023 there is profits of rs 30
(150-120), however, they cannot charge the incentive fee since the
value per unit(GAV) does not exceed the high water mark or the
value at which the previous incentive fee is already paid (that is rs
150).so, if the value is rs 160, then the GP could have taken incentive
fee on rs 10 profit (160-150).

06-04-2022

Equalisation:
different investors can come in to the fund at different points of
time, their profits as of crystallization date can be different.

ex: fund started in jan 2022, each investor paid rs 100 per
unit/share. next crystallization date is 30th June, as on that date
the GAV is rs 150 so these investors who came in jan made rs 50
profits. dhoni invested in the fund in march 2022 when the value
per units(GAV) Is rs 130. amitabh came in april when the GAV is
80.so all investor sin the fund as of 30th june did not made same
profits so their incentive fee cannot be same

all these investors who came in between will have different profits
and different incentive fee payable so these hedge funds equalize all
the accounts of the investors on crystallization date like 30th June
so from that time, profits made and incentive fee payable by
investors will be same.
one of the common method followed for this purpose is series
accounting .means issue 202202 series to investors came in feb,
series 202203 to investors who came in march etc fund knows the
GAV at which investors are allotted the units in each series.202202
series investors may be invested at rs 130, 202203 series investors
at rs 150 etc.

on crystallization date, each series accounts will be settled

separately for incentive fee.

Ex: if 202202 series units are allotted at rs 120 per unit and gav on
30th jun is 150, they made rs30 profit so incentive fee charged to
them will be rs 6(30*20%).

if all unit holders/investors accounts are settled on 30th june,

equalization of all the investors is done to settle these differences
in incentive fee payable by diff. series investors, there are
different methods, one of the most commonly used method is
compulsory redemption /issue of units.

Ex: all investors came in to the fund on 1st jan at rs 100 per unit.
kohli came in to the fund in April, paid rs 60 per unit. on 30th June
is GAV is rs 150, similar to other investors he will also pay incentive
fee on rs 50 profit (150 todays GAV 100 which is starting
GAV).however, he made more profit of rs.40 (100-60),so he has
extra benefit (Called as free ride) for rs 40.

so the fund need to collect extra rs 8 (40*20%) per unit from him.
assuming he has 100 units, he need to pay rs80 as se extra incentive
fee. the fund will redeem some of his units to that extent and
recover that money. if the GAV on that day is rs 160, fund will take
5 units (to recover rs80) from his account and sell.so he will have 95
units in the future.

similar way if an investor came at rs 140, then he made only rs 10

profit if gav on crystallization date is rs 150 .if he is also charged
incentive on rs 50 profit like others then he paid more. so, fund can
issue some extra units for that extra EST incentive fee. assuming
he paid extra incentive fee of rs 8 per unit (40*20%), he has 100
units then extra paid is rs 800, if value per unit is rs 160, issue
extra 5 units.

SIDE POCKET:
if a fund invested in some assets/securities and one/few of them
are in trouble, all investors in that fund will try to this can create
trouble at fund to arrange the money to all investors and the fund
manager may have to sell the good assets in the fund to pay the
investors.

to avoid this, the fund can separate "ILLIQUID, HARD TO SELL"

assets as a side pocket(Separate fund) and continue the main fund
as a separate fund. this will stop the investors to exit from the main
fund since there is no issue at the main fund level

ex:HDFC debt mutual fund invested rs 100cr like below

Company Securities rupees

Govt of india bonds Bonds 30
Reliance Debentures 40
DHFL Debentures 30
TOTAL 100
if DHFL company made default to repay interest or principal in time,
investors in this fund will get panic and try to exit from the fund.
fund manager has to sell reliance or govt of india bonds to pay to
those investors. entire fund can be come NIL/worthless once they
sold good investments and hold bad investments. this can bring more
panic in the market and investors may stop investing in to funds if
they see they make more losses in these funds etc so the fund can
separate DHFL investment as a side pocket/separate fund and
calculate separate NAV for that fund.. now investors will stay in
main fund having reliance and GOI (Govt of India)securities this is
allowed in debt mutual funds also in India, it is popular in hedge
funds.

Investments/securities used in hedge funds:

hedge funds generally use different securities to make investments

to make profits in short term arbitrage opportunities available in
the market etc. they use traditional securities like equity shares,
preference shares, bonds etc or exchange traded derivatives like
futures and options or over the counter derivatives like forward
contracts, swaps, contract for differences (CFD), swaptions etc..

Mortgage backed securities/MBS.(Securitisation process):

these are fixed income securities where the hedge fund/other

investor gets fixed income like interest.

these securities are created by converting the assets in to

securities (Securitization of assets, like REITS)

Ex: ICICI ban gave home loan to deepika, aiswarya, sharukh for rs
30cr.they can convert these assets(asset to bank, liability to
borrower) in to securities of 3cr mortgage backed securities at rs
10 each. if you have 1 lac, you can buy 10K MBS, you will get 8%
interest bank will collect the interest and pay to you. generally these
banks sell these to investment bankers/intermediaries, they will
transfer these assets to another company (SPV-special purpose
vehicle) and that APV will issue units/MBS to public. Investors are
happy to received fixed interest like 8% when other debt products
like govt bands are paying 4% interest. banks are happy to sell the
loans in the form of securities since they can issue more loans with
that money and make pay 8% to MBS.

ABS-Asset backed securities

same as MBS, banks can convert other loans like car loan, personal
loan etc into securities and sell to public, they are ABS.

Credit default swaps/CDS:

an investor who purchased MBS/ABS can enter in to CDS agreement
to protect from possible default of those MBS/ABS process

1. Pay some premium like Rs.2 per MBS security worth of rs100 and
get a right

2. the seller of CDS like insurance company will take that premium
and take that risk Credit risk is swapped/ exchanged.

3. if the MBS is defaulted(borrower did not pay in time), this

investor who also paid premium and bought CDS can get the money
from CDS seller like insurance company.
4. when CDS is sold, insurance company/other party thought this
MBS/ABS is safe, default will not happen so they sold this CDS by
taking premium, if no default on MBS, then premium is their income

5. investor buy this CDS as additional protection if the MBS is

failed/defaulted. investor already paid premium to CDS seller, have
right, if the security is defaulted, investor can go to CDS seller and
get the money invested in MBS.

CDS seller - American Insurance group(AIG) renaissance hedge

fund.

CDS BUYER – Renaissance hedge fund

MBS face value – rs 100

CDS premium – rs 2

07-04-2022

Derivatives
forwards

futures

Swaps

options

Derivatives are contracts that derive the value from the underlying
asset. underlying asset can be stock/gold like commodity, dollar like
currency etc .
these derivative contracts are used mainly for hedging (reduce the
risk) to avoid possible loss due to change in market rate of an asset.

ex: you have Infosys stock purchased at rs 1800, you want to sell in
june 22(after 2 months).you are predicting the stock price ma fall to
rs 1500, if so you will make loss.so you can use one of the derivative
contract like forward fix the selling price at rs 1800.opposite party
to contract will agree to buy at 1800 since that party is expecting
the price can go up to 2000.on the contract expiry date, you will sell
at rs 1800 per share and the opposite party buy it at 1800 so the
risk of loss due to change in the market price is avoided.

Same forward contract /any derivative contract will have different

price when the underlying asset price is changed so they are deriving
the value from the underlying asset, so they are called derivatives .

ex: if Infosys stock is rs 1800, futures contract can be purchased

or sold at rs 1800(appx), if the stock price is 1900. after a week,
this contare will also be trading at rs 1900 level so this contract
price is decided by the underlying asset.

all these derivative contracts can be grouped in to

1. OTC(over the counter) contracts like forwards, swaps, swaptions,

contract for differences, credit default swaps etc. these can be
used anywhere by the parties, they are not like option contracts etc
which are available only in a exchange. like BSE/NSE etc.

Ex: you want to sell rice of 100 tone so you made a call and entered
in to forward contract with reliance retail stores

to sell the rice after 2 months for rs 10 k per ton. there is no

intermediary like stock exchanges in this case.
2.Exchange traded derivatives these contracts like futures, options
etc are traded in stock exchange like Bombay stock. exchange(bse),
london stock exchange etc or commodities exchanges like MCX(multi
commodity exchange)

many people can use these contracts and buy/sell through demat and
online trading accounts opened through brokers.

since many people use the similar contracts and exchanges are
responsible to settle these contracts between parties, these
exchanges will have some rules on how these contracts will work so
they are called standardized contracts (like when the contract will
expire/how it will be settled etc)

these contracts are also used for speculation (make profits by

predicting the price movements of the underlying asset like stocks)

ex: if you think the Infosys stock will go down from rs 1800 today to
rs 1500 after a month, you can use one of these contracts and fix
the selling price at 1800, if the price actually falls to rs 1500, you
make rs 300 gain.

Most commonly

forwards futures

swaps

options

Forward Contract
this is a is a contract to fix the underlying asset for a future date
so any possible loss due to change in the price can be avoided

ex: a private equity fund invested in India, they have operation in

USA. they have invested 1cr dollars ,converted in to 75cr at rs 75
per dollar in jan 2022

they want to sell that asset after 3 months, they are expecting
rupee value may fall to rs 80 per dolor so they will get less dollars on
sale of that asset(if they sell for 80cr,they will make 5cr profit is
rupees but when they convert that in to dollars at rs 80per dollar,
they will get only 1 cr dollars so no profit in dollors).so they have
decided to use forward contract and buy US dollors at rs 75 only
after 3 months
Q : you have gold purchased at rs 5000 per gram in jan 2022 you
have to sell in march 2022.expecting the price will go down to rs
4000.so you agreed today to sell at rs 5200 in march, kalyan
jewellers agreed to buy at 5200 per gram. Now if the market price
is rs 4000 in march 2022, you still sold at rs 5200 as per contract
what is the gain/loss?

Gain of rs 1200 per gram since the market price is less, contract
price is more/better so ypu made gain of rs 1200 per gram

kalyan jewelers/counter party to the contract made rs 1200 loss

since they paid rs 5200 though the market price is only rs 4000.

(584800*30%) = 175440
Q . today by end of the day, price is 1380, can praneeth/buyer can

sell and make profits rs 4 per share?

yes, these exchange traded derivatives can be purchased or sold any

time gain is the diff between sell and buy price

(Sell price is high profit else loss)

diff between forward and futures

08-04-2022
OPTIONS:

Q.if the stock price on expiry date is rs 3000, what is your gain/loss
if you are the buyer?

since you have an option to buy at rs 2500 per share, you will
exercise/use the contract and buy at rs 2500.

you can sell immediately also in market for rs 3000 so the gain is rs
500 per share net gain will be rs 500-13.05=486.95

Q: if the market price on expiry date is rs 1500, what is gain/loss to

you(buyer of contract?

since market price is just 1500, you can directly buy from the
market, since this contracts is optional, no obligation to settle, you
can ignore/lapse the contract your max loss is premium already paid
which is rs 13 per share.

Q :what is the gain for the seller??

seller(like insurance company selling insurance policies) will get the

premium income which is the maximum gain to them their
assumption/prediction in case of call option is market will go down so
the call option buyer/holder will buy in the market so contract will
expire and the premium will become gain for them however if the
price goes in opposite direction to their prediction (if price goes up
in this case), they make huge loss.

Ex:you think the reliance share price goes up so bought call option
and paid rs 13 as premium adani thought the reliance price will go
down so he sold you call option, he is confident that stock will go
down to rs 2000 on expiry date, the stock price is rs 3000, you will
use the contract and buy the stock at rs 2500, Adani should buy at
3000 in market and sell to you at rs 2500 so he made rs 500 loss .

so max loss to adani(seller /writer of the contract) is unlimited like

rs 500 but max gain is rs 13 which is premium

underlying asset - bajaj auto

date - 18th Jan

View - bullish/positive

CMP/Jan 2022 – 3400

Counter party - rakesh Jhunjhunwala-bearish view

Put Option

Put option give the option to SELL but no obligation to sell

ex:
you are a mutual fund manager having reliance stocks purchased at
rs 2500

you are expecting the price will fall to rs 1500 in 2 months so you
can purchase a put option today and if the price falls below 2500, us
the contract and sell at 2500 if market price goes up, then ignore
the enter in to the contract and sell in the market Itself

Ex2:

you are a farmer cultivating wheat, cost of production of 1 ton Is rs

10000, you want to sell at rs 15000.but you have fear that market
price can be 5000 after two months by the time you get crop.so, buy
put option by paying rs 200 premium, that will give you right to sell
at rs 15000 per ton. if the market price is below 15000 ,exercise
the contarct and sell at 15000.if market price is 16K/ 17K etc(Above
15K), sell in market and ignore the contract.

Person having bearish view can use put option and buy that contract

Q : if you buy put option contract to sell 1kg gold at rs 10L by paying
premium of rs 50K, what is ur gain/loss if the price is rs 5L on
contract expiry date?

you have right to sell at rs 10L per KG and market price is only rs 5L
so you will us the contract and sell at rs 10L so the profit is 5L.

since premium paid is one time expense, net profit is rs 4.5L(5L-

0.5L)
Q. can you sell this today or need to wait we can close it before
also since there is liquidity till expiry?

We can close it before also since there is liquidity.

Q.if sold today, what os the gain/loss?

today premium 12.40 So yesterday you purchased at 11.05.

and sold today at rs 12.40

so 1.40 per share as gain

un profit % = 12.21719457

Q: if you hold the contract till expiry date, market price is 550,
what is gain/loss to you?

you have right to sell at 500

market is giving rs 550 so you will sell in market and ignore the
contract

so all premium paid is loss to you which is rs 11.05 per share

Q: you choose to buy the call option or sell the call option to make
more profits?

when a seller of option contract knows max gain is limited (to

premium), loss is unlimited, why do they sell these option contracts?

1.seller expect most of the contracts will expire out of the

money/worthless so the premium is gain(if insurance company sells
100 car insurance contracts, they will get rs 10L as premium, 1 car
may met with accident, cost can be rs 2L, remaining 8L is profit to
the company) .
2.they charge more premium when the risk is more like stock is
volatile or when strike prices changes.

3.like reinsurance contracts, these options sellers can buy some

options for them after selling some options so reduce the risk.

Ex:

if I sell tata motors put option, my assumption is price will increase

to 600 so contract expires

if I get a doubt that the price will o down, I will also buy one put
option like 400 strike so that will give profit if market falls.

PUT OPTION

Q .if the market price is 2600, what happens to contract?

since the market price is better, ignore the contract, max loss is
premium which is 78.50 per share strike price means the price at
which the holder of the contract can buy call) can sell (put)

spot price means the market price on expiry date/when the contract
is purchased/sold.

SWAPS

swap means exchange of cash flows between two parties

Mainly this is used to reduce the risk of loss due to change in the
market prices of some assets

Common swaps in the market are

interest rate swap, currency swap, total return swap etc

TRS-in total return swap, two parties agree to exchange the

returns/cash flows of two different assets owned by them.

ex:

you have equity shares of tata motors, purchased by expecting 20%

return/profit in the next 12 months your friend purchased
debentures of tata motors to get 8% interest since she is expecting
equity markets will give negative return so 8% int is good deal ,

after 2 months, markets are going down due to russia -ukraine

tensions, int rate change issues etc so you thought keeping money in
shares is risky so you proposed to swap equity returns with
debentures return with your fiend and both entered in to swap

agreement, total return swap

So any return(interest+ appreciation/depreciation on debenture) will

be paid to you and you will pay total return on equity (dividend
appreciation/depreciation) to your friend

Other types of swaps used in the market are

Interest rate swap-If you are receiving floating rate interest, you
can swap the fixed rate interest with other party, if you are
expecting the market int rates will go down so having fixed rate
int.is better option Currency swap-ex change dollar to rupee at a
fixed rate. ex.pay rs 75lacs, receive 1lac dollars each month.so chage
in currency rates will not impact you.

Swaption

Swap+option if you have equity shares of tata motors you will

continue to hold these shares if the company is expected to perform
well and declare profits in the books. if the company will declare
results after 10days, you have a doubt that results may be bad, then
you can enter is to TRS today with your friend so you can give equity
returns to your friend and take return on debentures from your
friend.

if you are not sure on how the results will be after 10days then you
can use this swaption contract. you can pay some premium like rs 5
per share today, get the right to enter in to swap or not after
10days, if the company results are good, shares price will go up so
Ignor ethe swaption contract and hold the shares if results are bad,
use the swaption contarct, enter in to swap agreement so you get
return on debt and your friend takes return on equity.

CFD(Contarct for difference)

these are similar to forwards, futures with small differences as

mentioned below

1.most of these CFDs are Otc contracts, traded any where(outside

stock exchange)

2.parties need to pay small margins like 5 to 10% on contract value

3.these are settled by paying the difference rather than physical

settlement ex:you agreed to sell 10 tons of wheat at rs 10000 per
ton. if the market price is 5000, you will still sell the wheat at rs
10K and make 5K profit in forward contarcts.in this forwards, you
will actually deliver the wheat and opposite party pay total amount

in CFD, since you made rs SK profit, opposite party pay you rs 5K per
ton, you can sell in the market for 5K and get total rs 10K per ton
but there is no actual delivery between the parties

Corporate actions:

These are actions taken by a company that impacts all stake holders.
stake holders can be share holders who owns the shares in that
company or debenture/bond holders who gave money/lend to that
company. these actions of the company that impacts the share
holders can be....dividends, bonus shares issue, stock split, buy back
of sharesetc.,

reasons for a company to announce these corp actions are to

distribute the profits to the owners (share holders) or to increase
the wealth of the investors (share holder wealth maximization) by
creating more liquidity for those shares in the market which can
increase the demand and increase the share price in market

Ex : if the share price of a company like eicher motors is trading at

rs 25000 per share, that company can announce stock split where
they will divide one share in to 10 shares so the stock price will go
down to rs 2500 per share. now,more investors will buy that stock
since price is less so the stock price will increase from rs 2500 to rs
3000 in few months. Investor wealth is now increased to rs
30000(10 shares 3000 per share) rather than having 1 shares at
25000. (this C.A is stock split where the fund reduces face value
per share for rs 10 to rs 5 or re.1 etc so more shares with low
denomination is created)

as an Investor, these fund houses like mutual funds, hedge funds

need to track these corp. actions on a regular basis and account
them in time so NAV calculations in that fund are correct.

Corporate actions

These are actions taken by a company that impacts all stake holders.
stake holders can be share holders who owns the shares in that
company or debenture/bond holders who gave money/lend to that
company. these actions of the company that impacts the share
holders can be....dividends, bonus shares issue, stock split, buy back
of shares

etc., reasons for a company to announce these corp actions are to

distribute the profits to the owners (share holders) or to increase
the wealth of the investors (share holder wealth maximization) by
creating more liquidity for those shares in the market which can
increase the demand and increase the share price in market

Exif the share price of a company like eicher motors is trading at rs

25000 per share, that company can announce stock split where they
will divide one share in to 10 shares so the stock price will go down
to rs 2500 per share. now, more investors will buy that stock since
price is less so the stock price will increase from rs 2500 to rs 3000
in few months. Investor wealth is now increased to rs 30000(10
shares 3000 per share) rather than having 1 shares at 25000. (this
C.A is stock split where the fund reduces face value per share for rs
10 to rs 5 or re.1 etc so more shares with low denomination is
created)

as an Investor, these fund houses like mutual funds, hedge funds

need to track these corp. actions on a regular basis and account
them in time so NAV calculations in that fund are correct.

Ex : if the company declared dividend today(22nd Jan) and payment

date is 22nd Feb 2022, fund cannot wait till 22nd feb to account

the c.a since they are not following the cash basis accounting system
rather they follow accrual basis accounting system. the fund
shoud account dividend income on ex date (one day before record
date), which is 10th Feb (if recod date is 11th feb) so NAV on
10th feb is correct

these fund houses/fund admins generally have a separate team to

capture and process these corp actions in time since it is important
to capture in time and they deal with large amount of
shares/companies so there can be many corp actions on a regular
basis

to capture these ca in time and find out if the fund as an investor

need to participate in the C.A or not etc., they classify these corp
actions to below 3 categories and process them...

1.mandatory c.a

2. Voluntary c.a

3.mandatory with choice C.A

(investor should participate investor has choice t dividend as

cash/shares.)

• Dividend
• Right issue
• Bonus issue
• Buyback of shares
• Stock split
• Mergers
• Acquisition
 • Spin off

mandatory C.As are those actions taken by a company where investor

should participate (once announced by the company after taking
necessary approvals in board meeting etc), as a share holder, if you
have shares, this c.a will impact you.

ex:if company issue bonus shares today, if you have shares on ex-
date, these free shares/bonus shares will come in to your account,
you don't need to participate/confirm to the company separately.

Voluntary c.a has option to the investor, if they want to participate

they can ,else, they can ignore this c.a.if they ignore(if not Informed
the copamy by applying for that c.a), these investors will not get
that benefit.

ex:

if company announces buy back of shares, they will only buy back 2%
or 10 of shares they have in that company.(if company has 100cr
shares, they may announce buy back of 5 cr shares) interested
investors should inform the company and apply for that process so
company will take that investor shares and pay money to them. other
investors can ignore this c.a so there is no change for them.

Mandatory with choice c.a will give the investor a choice initially, if
not exercised that choice, company will decide one option/ choice
and all remaining investors will follow that ca choice .
ex:

if company declared dividend and gave option to investors to take

cash or take shares and gave the deadline as 20th jan, investors has
to choose one option, if not exercises by that date, they will pay
cash to all other investors who did not exercised so that will become
mandatory at that time.

Imp dates in Corp Actions:

to record the corp actions in fund accounting, below dates are

important

1.announcemnet date-date on which the c.a is announced by the

company. On this date company will announce the details like ratio of
ca benefit (like % dividend/1:1 bonus issues etc) and record date etc

Ex : eicher motors announced stock split on 25th May and fixed

record date as 25th Aug 2020

2. Record date-on this date,company will consider the list of share

holders in their records (share holder register/names as per demat
accounts) and issue the benefit of c.a to them.

ex:if eicher motors says 25th aug 2020 as record date, they will
take list of share holders of that company on that day (end of the
day like 5pm), and issue new shares to these people. if your name is
there in that lise on 25th aug, you will get the new shares with face
value of rs 1 on payment date(generally around 10 days from record
date).

3. Ex-date This is most important date for investors, if they buy

shares on this day, they WILL NOT GET the benefit of ca since the
shares are trading EXCLUDING the BENEFIT of C.A that day. This
is one BUSINESS DAY before the record date.

Ex: If eicher motors stock split record date is 25th aug, Tuesday,
Ex-date is 24th Aug Monday. if you buy on Monday 24th aug or
later, you will not get the stock split benefit since your name cannot
appear in the share holders list on record date in stock exchanges
(Current system), it will take 2 working/business days to settle all
the trades happened in that stock exchange.(T+2 settlement).

Ex ; If you purchase stock on Monday, stock exchange will credit

the shares in your DEMAT account by Wednesday

Trade day (T) - Monday

T+1 day -Tuesday

T+2 day -Wednesday

Since stacks are trading without the benefit os c.a on ex-date,

share price will automatically adjusted in the markets on this day ex:
eicher motors stock split record date is 25th aug 2020(Tuesday),ex
date is 24th aug (Monday).on that day 24th/Monday), stock price
started trading at rs 2100 appx which was earlier trading at rs
21000(appx) since 1 share is split in to 10 shares Fund accounting
teams can record this c.a on ex-date and give effect in NAV
calculation. If not updated on this date, NAV will be incorrect .

ex:

if the fund has 1 share, they will report rs 21000 as portfolio value
before the ex date.on ex date share price decreases to rs 2100,
they MUST update the no.of shares as 10 so the portfolio value will
still be 21000 ( 10shares 2100 per share),if qty is not updated and
left as 1, the pricing team/valuation team(team responsible to
update the market values for nav calculations) will take the today's
market value which is rs 2100 and consider old qti which is 1 share
and report the market value of portfolio as 2100 and report the loss
as unrealized loss

entry on ex date for a CA like dividend is

DIVIDEND RECEIVEBLE A/C DR 1CR

TO DIVIDEND INCOME 1CR

This will be reversed when received , payment made

BANK A/C DR 1CR

DIVIDEND RECEIVEBLE A/C 1CR

1.Dividend

if a company has profits and they want to pay these profits to

investors, they declare dividend this is most common c.a by most of
the companies. companies not having expansion pains will distribute
the profits. if company has expansions they use profit to reinvest so
no dividends.

2.bonus shares

these are free shares issued by company to investors (existing

investors) by converting reserves (accumulated profits/profits of
previous years).in fund accounting we update the quantity of shares
in the books when this is done. if it is 1:1 bonus issue, if the fund has
100 shares they will update the 100 more shares in qty.
3.Stock split

stock face value reduced from rs 10 per share to rs 5/2/1 etc so

more shares are created in that company

4.spin off

one company is dividend in to many companies or two companies by

spinning off/demerging one division to a separate company.

ex: if reliance company has 3 businesses like telecom,

petrochemicals, retail, they can spin off telecom/jio as separate
company to manage it better.

5.buyback of shares

in this case the company buy back some shares from investors, share
price will increase in this case since no.of shares are reduced
5.rights issue-issue shares to existing share holders when company
need more capital generally they sell at discount to old investors, it
is righ to old investors. if they are not interested, company will sell
to others and raise money.

Reconciliations
These fund houses have to reconcile the data before finalising the
NAV and sent to investors. Since the NAV process include many
parties like custodian, fund administrator, fund house/investment
manager, prime broker etc., there can be differences between the
data of tehse parties.

Ex:
Goldman sachs hedge fund has below parties in the NAV life cycle
Goldman sachs- general partner/investment manager-who launched
the fund, managed the fund, responsible to send NAV to investors
and regulators etc.

State street- find administrator who prepares the financial

statement and NAV, operating bank accounts of the funds like make
payments on behalf of the fund, provide audit support etc

BNY Mellon/State street- custodian who keep the assets of the

fund like shares in their custody. they also update the corp actions
like bonus shares in their accounts so number of share owned by the
fund is correctly reported.

HSBC securities/goldman sachs securities- prime broker, like a

stock broker they help these fund houses to open demat account,
trading account, place order in the stock exchange on behalf of fund
houses.

there is regular dependency, co-ordination between these parties to

manage the fund, to report NAV. There can be discrepancies in the
data between two parties. All line items/important line items in the
balance sheet will be reconciled between two parties to ensure they
are correct.

Ex :if the investment manager like Goldman sachs prepares

management fee and incentive calculations, they will compare the
calculations made by state street/fund admin and ask the fund
admin to update/correct .
similar way they reconcile all other important line items like bank
loan, Investments, cash etc.,

Most important line items or line items having more balance in a fund
are investments and cash.

ex:if the fund has total assets of 500cr, investments can be 450cr
and cash can be 30 cr, other assets can be 20cr to ensure these two
line items are correct, they do the below reconciliation. most of the
times this recon is out sourced to other company where many team
members will do this as a separate task(if GS out sourced fund
accounting to SST, they may give this recon to HCL State street
these teams main work is to complete recon of 100s of funds so fund
admin can use that finalized numbers in NAV calculations)

to reconcile investments and cash, the below reconciliations are

done by these recon tea

1.position reconciliation-

to ensure the position of investments or value of investments is

correct between two sets of data

ex: in goldman sachs hedge fund, apple company shares reported by

GS are 1000 and the balance of apple shares in fund admin books are
950.similar way there can be difference between prime broker and
fund admin books. reason can be.

A. GS/investment manager asked to buy 1000 shares of apple at rs

500, prime broker placed the order for 1000 shares, they are able.
to buy only 950 shares at that price Is rs 500 per share. market
price went up to 520 that day so they are not able to buy balance
shares in this case, GS numbers to be updated ts 950.

B. apple company announced bonus shares of 1:1 which means if the

fund has 100 shares, they will get extra 100 shares at free of cost.
today is the ex-date(one day before record date, date on which the
fund can record the benefit in books), quantity of shares are
updated by custodian on the same day but fund administrator and
investment manager forgot to update the quantity. so one
sources(custodian ) is reporting 200 shares and others are reporting
only 100 shares, in this case custodian data is correct, others has to
update.

2.cash reconciliation-

this is to ensure the cash balance of each fund is correct.

ex: as per prime broker who buy and sell shares on behalf of the
fund, the closing balance of goldman sachs hedge fund is rs 10cr.

as per fund administrator books, it is reported as rs 9 crore.

reasons for difference can be

a. one trade(purchase of investment) is made in US dollars and paid

1000 us dollars, it is updated as rs 1000 paid by one party.

B. One trade is completely missed by one party so cash balance is

not updated

This recon if made between two sets of data, that data is from two
different companies, they call it as external reconciliation If that
recon is done between two teams in same company, it is internal
reconciliation.

ex:
if data of GS and SST is reconciled it is external recon, if data of
Front office of GS (where trades are accepted and placed into stock
exchange) and back office (where contarct notes are prepared,
profits are calculated on tardes), it is internal reconciliation

09-04-2022

Intercompany entries:
GS asia fund paid expenses of GS europe fund

receivable from affiliates A/C dr 100

to bank A/C 100

when received from GS europe fund

Bank A/C dr 100

to receivable from affiliates 100

in GS europe fund

professional fee A/C dr 100

to payable to affiliate A/C 100

when paid

payable to affiliate A/C dr 100

to bank A/C 100

IF the masterfund call the money from feeder fund, and feeder
fund invest in master

1.for feeder it is an investment in master

2.for master it is capital received from investors

When feeder fund received money from their investors

BANK A/C DR 500

TO CAPITAL CONTRIBUTIONS RECEIVEBLE A/C 500

When they invest money into master

INVESTMENT IN MASTER A/C DR 500

TO BANK A/C 500

In the master books entries are same

1.when called the money.

cap cont.receivable A/C DR

to Capital

2. BANK a/c dr

to cap cont.receivable A/C

Mutual funds-few other imp points

Q. What Is NAV,why important?

NAV stands for net asset value

this is calculated as assets - liabiliaties

ex:if a fud has 200cr assets and 20cr liabilities, net assets are
180cr

in case of mutual funds, teger are many investors so they don't

prepare/update this NAV at each investor level

so they calculate the NAV per unit/share

so NAV per unit = NAV of the fund/no.of units in the fund

assuring this fud has 10cr units,NAV per unit is 180/10=18

if an investor has 100 units, his NAV is 100*18- 180.he can decide to
sell all units and get 180 or sell 10 units only

etc, that transaction is settled based on that day NAV

Note: 1.this NAV can be calculated using Balance sheet Approach as

above or Profit and loss account approach.

in P&I approach, opening balance of NAV plus net profit per unit ofr
today is the closing NAV.

Ex:NAV per unit is 18, net profit per unit is rs 2 for today,closing
NAV is rs20

any capital activity like subscriptions and redemptions should also be

considered for calculating this
Q for management fee payable, entry was posted in Jan 2022 for
10cr, it is paid in feb 2022. Now accountant forgot to reverse the
entry of payable, recorded again expense(mgt fee exp 10 dr to Bank
10cr), what is the impact?

since the liabilities are reported more and not reversed, NAV is
reported less

to correct this the entry will be

management fee payable. a/c dr

to managenet fee a/c

Note:any increase asset(or income) will increase assets, net asset

value.

any increase in liability(or expense) will decrease, net assets.

Equity funds
these funds invest in shares of listed companies. These are more
risky compared to debt funds, bank fixed deposits etc since they
can also give loss if the share prices reduced in market.

depends on where they are investing there can be many categories

like

Large cap funds-invest in top 100 companies in India by market cap

(market cap no.of shares in that company market price)

ex: reliance is biggest company in Indis by market cap with appx

16lacs crores market cap.if share price is 2000, company has 800cr
shares then market acpitalisation is 16 lac crores (2000*800)

Midcap funds-invest in companies between 101 to 250th rank by

market cap
small cap-invest in companies below 250th rank (251 to 5000,
assuming there are 5000companies in indian stock exchanegs)

Sectoral funds like banking funds-they invest in shares of that

sector companies like hdfc,icici etc

focused funds-invest in less companies like 25-30 than investing in

60 companies(portfolio of companies in that fund is less)

DEBT FUNDS:
they invest in debt/fixed income securities like debentures/bonds.
investors will get interest at 6 to 10% general and get the principal
back on maturity like after 5 years so they are more secured/less
risky

ex: if reliance need money of 100 cr, they can issue debentures of
1cr at rs 100 per debenture at 10% interest/coupon rate, tenure is 5
years. now a mutual fund will buy I lac debentures and invest 1 cr,
they will get 10 lacs int each year(1cr* 10%) and get that 1cr back
after 5 years.

If long duration fund invest in long term bond like 10 years its more
risky since company may default to repay after 10 years though that
is good company today so long term bands, long term funds pay more
interest/more return SITA short term funds like money market,
liquid funds etc invest in securities having less than 1 year maturity
so less risk and low return.
Hybrid funds
they invest in both types like shares and bonds

if they invest 50% in debt and 50% in equity it is balanced funds

more than 50% in equity, it is aggressive funds

more than 50% in debt it is conservative hybrid funds

active vs passive funds

in active funds, fund manager decides what to buy and what to sell
using the fund money in passive funds, they follow an index like nifty
50.this index is developed by stock exchange like NSE with top 50
stocks

in In India so, if the NSE include zomoto and remove wipro after 2
years, this fund also do the same.

These passive funds are more popular now for below reasons

1.they have top stocks in the portfolio so we can expect consistent

retun in long term

2. expenses are less since no research and active management is

tehre in these funds

(most of the passive funds charge managemnet fee around 0.1 % to

0.5%)

popular examples for passive funds are

1.Index funds

2.ETF
Q.diff between index fund sand ETF?