Case 004Fund economics, NAV and LP decisionsCore
Varsana Asset Management runs Rs 5,000 crore at 1.5 and 15, with Rs 60 crore of annual costs. What does the manager earn at gross returns of 0%, 10% and 20%, and at what AUM does it break even in a flat year?
1The situation
Varsana Asset Management runs one long-short equity fund with Rs 5,000 crore of assets. It charges a 1.5% management fee on assets and a 15% performance fee on gains after the management fee, with a high-water mark. Its annual costs, including salaries, data, technology, office and compliance, are Rs 60 crore.
An allocator doing due diligence wants to know whether the manager can survive a bad year without cutting the research team. Treat the performance fee as calculated once a year on the year's gain.
2Your task
What does Varsana earn at gross returns of 0%, 10% and 20%, and what is the smallest fund it can run without losing money in a flat year?
Quick check
In a year with a 0% gross return, what is Varsana's profit?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
Varsana earns a profit of Rs 15 crore in a flat year, about Rs 79 crore at 10% and about Rs 154 crore at 20%, and breaks even in a flat year at Rs 4,000 crore of assets. The Rs 75 crore management fee is the only revenue that arrives every year. Below Rs 4,000 crore, a flat year means a loss.
Step 1What does the manager earn in each scenario?
Split revenue into its two pieces, because they behave completely differently. The management fee is 1.5% of assets and arrives whatever the return; the performance fee is 15% of the gain after that fee and arrives only when the fund makes money. At a 10% gross return the fund gains Rs 500 crore, the management fee takes Rs 75 crore, and 15% of the remaining Rs 425 crore is Rs 63.75 crore of performance fee.
| Gross return | Gain | Management fee | Performance fee | Revenue | Costs | Profit | Investor net |
|---|---|---|---|---|---|---|---|
| 0% | 0 | 75 | 0.00 | 75.00 | (60) | 15.00 | -1.50% |
| 10% | 500 | 75 | 63.75 | 138.75 | (60) | 78.75 | 7.22% |
| 20% | 1,000 | 75 | 138.75 | 213.75 | (60) | 153.75 | 15.72% |
Step 2At what size does a flat year break even?
In a flat year the only revenue is the management fee, so the break-even fund size is the cost base divided by the fee rate. Rs 60 crore over 1.5% is Rs 4,000 crore, so Varsana can shrink by a fifth before a flat year turns into a loss. A corner shop whose rent is covered by its regular customers can survive a bad festival season; one that depends on the festival rush cannot. Varsana is the first kind, but only just.
Step 3What happens after a losing year, and why does the allocator care?
Suppose the fund loses 10%. Assets fall to about Rs 4,500 crore, below break-even plus a cushion, and the management fee drops to about Rs 67 crore. Worse, the high-water markThe highest previous value of an investor stake; the manager earns no performance fee until the fund climbs back above it. means no performance fee until the loss is recovered, which at a 10% gross return takes about a year. A manager living on its management fee after a drawdown has an incentive to protect assets rather than returns, and the best analysts leave when bonuses stop. The allocator's judgement: Varsana is viable at today's size, but thinly. Ask how costs flex, how bonuses are funded in a year with no performance fee, and how much of the team's pay depends on it.
Where candidates lose it
The most common slip is charging the performance fee on the whole gross gain, 15% of Rs 500 crore, which gives Rs 75 crore instead of Rs 63.75 crore. The question said after the management fee; the base matters.
The second is answering only the good years. Allocators ask this question to learn whether the manager survives a flat or losing year, so lead with the Rs 15 crore and the Rs 4,000 crore break-even, not the Rs 154 crore at 20%.
What the interviewer asks next
- The fund loses 10% this year and makes 12% next year. What performance fee does Varsana earn next year?
- Would you rather Varsana cut its fee to 1% and 20%? Show who gains in each scenario.
- How would a 6% hurdle change the performance fee at a 10% gross return?
Company names and figures are illustrative.