Case 079Fund economics, NAV and LP decisionsWarm up

Kairav Capital, with AUM of Rs 60,000 crore, pays a fund administrator 3 basis points a year for middle-office work. Building it in-house would cost Rs 12 crore a year plus Rs 15 crore to set up. Using the data, write the recommendation: in-source or not, and at what AUM does the answer flip?

D.E. ShawNew York · 2025

The situation

Kairav Capital runs Rs 60,000 crore across four strategies. Its middle office, meaning trade capture, daily position and P&L reconciliation, corporate actions and collateral tracking, is outsourced to a fund administrator for 3 basis points of AUM a year. The same administrator also strikes the official NAV, and will keep doing so whatever Kairav decides.

The chief operating officer proposes an in-house team of 22 people with its own systems, costing Rs 12 crore a year, plus Rs 15 crore to build, migrate and run in parallel for six months. AUM has grown from Rs 45,000 crore three years ago. You have an hour to send a two-page recommendation.

Your task

Should Kairav in-source the middle office, how long does the set-up take to pay back, and at what AUM does the answer flip?

Quick check

Ignoring the set-up cost, below what AUM does outsourcing become the cheaper option?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

In-source, with conditions: it saves Rs 6 crore a year and repays the set-up in 2.5 years. The administrator costs Rs 18 crore at 3 basis points of Rs 60,000 crore against Rs 12 crore in-house. The answer flips below Rs 40,000 crore of AUM, or Rs 50,000 crore once the set-up is spread over five years, so a one-third fall in assets would reverse it. Keep the administrator for the official NAV.

Step 1What does each option cost at today's size?

Think of renting a car against buying one. Rent scales with how much you drive; the car you own costs roughly the same whether you drive it or not. Outsourcing is a variable cost that grows with AUM; the in-house team is a fixed cost that does not. At Rs 60,000 crore the administrator charges Rs 18 crore a year, Rs 6 crore more than the team would cost, and the gap widens with every rupee of growth.

Outsourcing scales with AUM; the in-house team costs the same at any size6121824Outsourced, 3 bpsIn-house Rs 12 crorewith set-up over 5 years: 15Flip at Rs 40,000 croreToday: Rs 18 crore020,00040,00060,00080,000AUM, Rs crore (annual cost on the vertical axis, Rs crore)in-sourcing cheaper
The administrator's fee rises with AUM and reaches Rs 18 crore at Kairav's Rs 60,000 crore, against a flat Rs 12 crore in-house, so in-sourcing is cheaper above Rs 40,000 crore, or above Rs 50,000 crore if the set-up is spread over five years.
Step 2How long does the Rs 15 crore of set-up take to come back?

Divide the one-off cost by the yearly saving: Rs 15 crore over Rs 6 crore is 2.5 years. A cleaner way to judge it is to spread the set-up over the life you expect from the build, say five years, which adds Rs 3 crore a year and lifts the break-even AUM to Rs 50,000 crore. Kairav clears that with room to spare today, and the proposal gets better as AUM grows, since the in-house cost does not scale with it.

The relationship
AUM∗=in-house costfee rate=120.0003=40,00012+15/50.0003=50,000AUM^{*} = \frac{\text{in-house cost}}{\text{fee rate}} = \frac{12}{0.0003} = 40{,}000 \qquad \frac{12 + 15/5}{0.0003} = 50{,}000
in-house costRs 12 crore a year for the team and systems
fee rate3 basis points, 0.0003 of AUM
15/5set-up cost spread over five years
What it says in wordsThe flip point is the AUM at which 3 basis points of assets equals the fixed cost of doing the work yourself.
AUM, Rs croreOutsourced, Rs croreIn-house, Rs croreSaving from in-sourcing
30,0009.012.0-3.0
40,00012.012.0+0.0
50,00015.012.0+3.0
60,00018.012.0+6.0
80,00024.012.0+12.0
The saving from in-sourcing is minus Rs 3 crore a year at Rs 30,000 crore of AUM, zero at Rs 40,000 crore and plus Rs 12 crore at Rs 80,000 crore, before the one-off set-up cost.
Step 3What could make the recommendation wrong?

Three things, each worth one line in the memo. First, AUM: a fall of 33% to Rs 40,000 crore erases the saving, and hedge fund assets can fall that fast after a poor year and a wave of redemptions. Second, the in-house cost creeps: salaries and system licences rise every year while the fee rate stays flat. Third, the transition itself: reconciliation breaks during migration are how funds misstate positions, and investors doing operational due diligence ask about exactly this.

Step 4How do you write it up in two pages?

Lead with the answer and the number that could reverse it, then the support. Page one: the recommendation in one sentence, the Rs 18 crore against Rs 12 crore comparison, the 2.5-year payback and the Rs 40,000 to 50,000 crore flip range. Page two: the conditions, a six-month parallel run, the administrator kept for the official NAV and a shadow check, and a review trigger if AUM falls below Rs 45,000 crore. A memo that gives the conditions under which it would change its mind reads as judgement; one that only lists pros and cons reads as homework.

Where candidates lose it

The frequent miss is comparing Rs 18 crore with Rs 27 crore, the running cost plus the whole set-up in one year, and rejecting the idea. The set-up is paid once; it belongs in a payback or spread over the build's life.

The second is recommending in-sourcing with no flip point and no conditions. The interviewer is testing whether you see that the answer depends on AUM, which a hedge fund does not control.

What the interviewer asks next

  • The administrator offers to cut its fee to 2 basis points to keep the business. What now?
  • Why keep the administrator for the official NAV even after in-sourcing?
  • How would you phase the migration to limit reconciliation breaks?

Asked at D.E. Shaw, Strategy and Operations, New York, 2025 (Wall Street Oasis): Received a case study within an hour, had to write a 2 page long response.

Company names and figures are illustrative.