Expense allocation is a critical process for private equity, hedge funds, pension funds and other asset managers often performed manually through the use of Excel-based spreadsheets. However, due to the complex nature of fund expense rules that differ from fund to fund, managing this process manually can lead firms down a path of operational risks that have the potential to result in hefty regulatory fines, a loss of reputation or monetary loss to the management company.
Without a robust system in place to identify correct expenses, firms often take the approach of allocating directly to funds without having the proper documentation to support their claim or they simply have the management company pay upfront to avoid charging the funds directly. By taking the first and arguably more risky approach, firms may find themselves in hot water with intervention by auditors and government entities.
In fact, the SEC recently charged a NY-based private equity fund with conflicted expense reimbursement. Generally, the management company pays the vendors and seeks reimbursement later from funds. In many cases, the fund allocations are unknown at the time when vendors are paid, so the expenses are reallocated among funds after several weeks. The reallocation of an expense is required when the underlying expense allocation rules for an already paid/processed expense have been changed and should now be done using an updated method.
As one can imagine, this process requires identifying the new entities that should pay or should have paid the expense, booking reversals and new journal entries, and making intercompany or interfund payments. At this stage, the vendor has already been paid so the new entities just need to reimburse the other entities that overpaid initially. The overall business of reallocation can take several days to several weeks depending upon the sophistication of reallocation and the number of entities involved.
Previously, the need and challenges of reallocation were repeatedly raised by private equity and credit shops whose investment styles are mostly deal-driven. Based on changes to deal status (e.g. from a prospect to a dead or closed deal), the allocation rules could change and require expense reallocations. This problem is now being increasingly reported by hedge funds who want to pay the vendor upfront, likely from a management company account, and perform allocations later. Once the new expense allocations are determined, the management company seeks reimbursement from the funds or the other entities. The issue here is that the reallocations are done several weeks or months later and if a proper audit trail has not been maintained, chances are that many expenses may go unnoticed or could be misallocated due to changes in the underlying data. Additionally, the reallocation process itself is laborious and requires sharp attention.
Many of the challenges related to identifying the new entities, booking reversals and new entries in GL systems, and reimbursing the entities that overpaid can be solved effectively and efficiently by the use of a well-designed expense allocation system. To achieve success, asset managers should ensure that their system:
- Can manage supporting reference datasets
- Has flexibility to accommodate allocation and reallocation rules
- Tracks deal status and identifies expenses that should be reallocated
- Integrates well with GL and payment systems
An expense allocation system that can support the most complex business cases will save hours of manual effort and frustration among the team, be more accurate and complete, and boost compliance across the board.
IVP’s expense management solution for the asset management industry helps managers efficiently and accurately allocate expenses and manage payments. To learn more about IVP Expense Manager, please visit the page IVP EXPENSE MANAGER or contact email@example.com.