Common Expense Allocation Errors and How to Solve Them

Expense allocation is crucial for asset managers because it ensures transparency and accountability in operations. Asset managers are responsible for managing client investments, and allocating expenses has a significant impact on the returns of these investments. Furthermore, accurate expense allocation helps guarantee all investors are treated fairly, especially for pooled investment vehicles.

Expense allocation errors have high stakes. When errors occur, the asset manager could face fines or penalties from the SEC. Overcharging funds can result in particularly heavy fines, while undercharging funds can directly affect the management company’s revenue. Of course, errors also erode the trust of clients and are ultimately detrimental to the firm’s reputation.

In this article, we will review some common expense allocation errors and show how the IVP Expense Allocation Solution helps solve them.

1. Applying Expense Allocation Methodology Inconsistently

Inconsistent application of expense allocation methodologies occurs when asset management firms use different criteria or methods to allocate expenses across various portfolios or funds. This can be seen when operational, performance-related, or management fees are treated differently from fund to fund. It may also lead to allocating expenses to the wrong department.

This type of error typically happens because of a lack of standardized procedures, failure to update allocation methods, or the lack of clear guidelines on how to allocate expenses appropriately. Without clear and precise guidelines, different team members may use their discretion differently in similar circumstances, leading to an unfair allocation of expenses that could undermine investor trust. Inconsistency may also lead to non-compliance with regulatory requirements and operational inefficiency as well.

The IVP Expense Allocation Solution helps asset managers exert greater control over the allocation process, providing a standardized and centralized approach. Specifically, the solution sets pre-defined templates and rules for expense allocation that outline the criteria for expense distribution among various departments and take guesswork out of the process. It also uploads data automatically and facilitates approval from the relevant stakeholders.

Together, workflow automation and pre-defined rules reduce the risk of human errors and inconsistencies. By centralizing expense data and allocation methodologies, the solution also allows for real-time tracking and monitoring of expenses. It also provides audit trails that make it easier to review and validate allocations and ensure regulatory compliance.

2. Overcharging and Undercharging

Overcharging occurs when an asset manager charges more fees or expenses than what should be rightfully charged based on the fund’s AUM, performance, or another agreed-upon fee structure. Conversely, undercharging occurs when an asset manager charges lower fees than they should, given the fund’s AUM, performance, or fee structure. Both scenarios happen because of simple human errors in fee calculation.

The IVP Expense Allocation Solution calculates fees automatically to avoid these types of errors. It can also set dollar limits (hard and soft) for funds or management companies based on expense types or invoice categories to promote consistency and transparency.

3. Neglecting Scalability

It is common for asset managers to neglect future growth when setting up the expense allocation process. In general, expense allocation, tracking, and payments is often done with simplified spreadsheets and data collected by the IT team. However, as the fund grows, scaling up this approach is impossible due to the large number of expense allocation methods to support and complex rules to apply. At this point, an automated solution becomes necessary.

The IVP Expense Allocation Solution, for example, can easily scale to accommodate new methods and rules as the portfolio expands. The solution allows users to define and modify expense allocation rules as needed. It also tracks any changes to allocation rules, providing a transparent audit trail of all adjustments that is extremely valuable for compliance reporting.

Of course, the IVP Expense Allocation Solution also automates the allocation processes, which reduces the need for manual intervention and helps ensure asset managers can manage allocation efficiently, no matter how large or complex the business becomes.

4. Bad Data

Data errors occur frequently in expense allocation due to the manual nature of spreadsheets. Common mistakes include incorrect data entry, inconsistent data, outdated data and faulty manual calculation of allocated amounts.

The IVP Expense Allocation Solution minimizes data errors by incorporating data validation and establishing automated error detection with alerts. The solution automates invoice capture with optical character recognition (OCR) technology that eliminates most of the human errors from the AP process. Asset managers can also upload data directly from a spreadsheet. The solution also has API integrations that allow the accounts payable team to bring in data from other accounting tools like QuickBooks, Workbook, NetSuite, and others. All of these capabilities streamlines the expense allocation process and reduce the risk of data errors.

To avoid these four common expense allocation errors, asset managers need to implement a robust and transparent allocation processes, use appropriate allocation methodologies, regularly review and audit allocation practices, and ensure regulatory compliance. The IVP Expense Allocation Solution helps asset managers do all of this with a cloud-based SaaS platform that streamlines allocations, helps funds stay compliant, increases transparency, and automates the expense allocation process to improve efficiency.