Mastering Expense Allocation

An overview of industry challenges and the best practices that solve them.

Expense allocation continues to remain an area of concern for hedge funds and private equity funds that possess a predominantly manual process, as even one small error can cost a firm its resources and reputation.

From capturing invoices via emails to the use of complex spreadsheets to calculate allocations, these manual processes are riddled with risks. Managers must strive to eliminate these risks to ensure compliance – not only with their firm’s internal policy but also with increased regulation across the industry.

In a recent Indus Valley Partners webinar, Director Ashish Kumar Jain set the stage by discussing the growing attention expense allocation has received lately from regulatory bodies like the Securities and Exchange Commission (SEC). Following the release of the 2021 Examination Priorities Report – where disclosures related to fees and expenses were among its top five priorities – the SEC announced just last month that it would propose new rules to protect investors of private funds by “requiring registered private fund advisers to provide investors with quarterly statements detailing certain information regarding fund fees, expenses, and performance,”[1] further underscoring its strong focus.

So, what does this mean for managers using a partially automated process that still relies on manual work – representing 71% of our webinar poll respondents? According to Jain, they must do things like evaluate and assess their expense allocation policy and process to ensure consistency, accuracy and scalability, create a documented and auditable expense allocation workflow that clearly defines fund and management accounting, and leverage technology to systemize. Therefore, he defines the best practices to help managers design a scalable and robust expense allocation process that lasts, including:

• Automated Data Capture: Use technology to automate invoice capture, thereby reducing manual intervention and replacing with supervision.
• Workflow-Based Approach: Clearly define workflows that each type of invoice follows, and define the roles and actions that people can take.
• Removal of Allocation Method Discretion: Rather than relying on memory, set up a process that determines allocation rules, thereby reducing errors caused by employee discretion/inconsistency.
• Automated Data Sourcing: Make data, such as allocation basis, available systematically.
• Execution of Expense Policy: Enforce the expense policy automatically, which will raise alerts and warnings for disallowed expenses.

 To hear more of Jain’s insights, view the on-demand recording of the webinar HERE or visit our website for information on our Expense Allocation Solution.

[1] “SEC Proposes to Enhance Private Fund Investor Protection,” U.S. Securities and Exchange Commission, February 9, 2022.