The evolving view appears to be that an investment in a hedge fund is less like the purchase of a product, and more like the negotiation of a customized contract; and this view applies whether the investment is in a commingled vehicle (with the terms abridged by a side letter) or a bespoke product like a “fund of one.”  Under this “contractual” view of hedge fund investing, one of the more vigorously negotiated points relates to the allocation of organizational, operating and other expenses.  Expenses are a big deal for investors because they are high, going up and can reduce investor returns, often dollar for dollar.  See “Citi Prime Finance Report Dissects the Expenses of Running a Hedge Fund Management Business, Identifying Components, Levels, Trends and Benchmarks,” Hedge Fund Law Report, Vol. 6, No. 1 (Jan. 3, 2013).  The concern is especially pronounced for “anchor” or early investors in a hedge fund, who typically bear a large proportion of expenses until the burden can be spread among later investors.  See “Ernst & Young’s Sixth Annual Global Hedge Fund Survey Highlights Continued Divergence of Expectations between Managers and Investors,” Hedge Fund Law Report, Vol. 5, No. 44 (Nov. 21, 2012).  From the manager perspective, the analysis is less zero-sum.  Assuming fixed revenue, internalizing fund expenses would reduce the management company’s profit.  But revenue is not fixed, and internalizing the right types and amounts of expenses can increase management company revenue by more than the internalized amount.  This is because internalizing expenses can materially assist in capital raising, which in turn grows assets and increases fee revenue.  In other words, given the intense focus on expenses on the part of many investors, conceding on expenses can sometimes be the “but for” cause of an investment that generates fees well in excess of the relevant expenses.  This is not necessarily rational or logical on the part of investors, but investment decision-making in the hedge fund world (as in other investment settings) is often governed more by investor psychology than detached rationality.  For managers confronting this reality, the question is how much to concede on the expense issue, and how to concede with dignity – that is, how to structure an expense allocation mechanism that is fair, workable and predictable.  Increasingly, managers are answering this question with a simple but effective tool: a contractual cap on organizational and operating expenses to be borne by the investor.  This article is the first in a two-part series weighing the opportunities and drawbacks of expense caps.  Specifically, this article addresses what expense caps are; whether expense caps can be offered only to select investors; expenses typically covered by caps; structuring of expense caps; and the levels at which expense caps are set.  The second installment will address topics including whether expense caps should apply for only a limited period; benefits and drawbacks of offering expense caps; and recommendations for managers in negotiating and implementing expense caps.