How Should Hedge Fund Managers Approach the Allocation of Expenses Among Their Firms and Their Funds? (Part Two of Two)

For hedge fund managers, how to allocate expenses among their management entities and their funds is a high-stakes and challenging topic for at least five reasons.  First, the quantity and variety of expenses involved in operating a hedge fund management business have increased dramatically in recent years, thanks in large part to recent regulation.  Second, there is little regulatory guidance on best practices for expense allocations.  Third, institutional investors are bringing a stricter level of scrutiny to bear on expense allocations.  Fourth, it is difficult to ascertain how other managers are treating similar expenses.  Fifth, as explained more fully below, there are trends afoot in hedge fund disclosure documents that raise the stakes in this area.  In short, allocation of expenses is a classic hard question for hedge fund managers.  This article – the second in a two-part series – tackles some of the thorniest sub-issues head-on.  In particular, this article discusses expense allocation methodologies and practices actually used by hedge fund managers, and the rationales for their use; challenges associated with disclosure of expense allocation practices; approaches for handling allocation of expenses when disclosures are ambiguous or silent with respect to specific expenses; best practices in this area; and the appropriate role of independent boards, advisory committees and service providers in reviewing a manager’s expense allocation policies or decisions.  The first article in this series provided an overview of the key issues and challenges inherent in allocation decisions, and outlined various regulatory and other concerns posed by allocation practices.  See “How Should Hedge Fund Managers Approach the Allocation of Expenses Among Their Firms and Their Funds? (Part One of Two),” Hedge Fund Law Report, Vol. 6, No. 18 (May 2, 2013).

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