A fixed monthly charge on a growing NAV falls hardest on the investors who arrived first.
Under US GAAP a fund that offers its shares continuously defers its offering costs and amortises them in a straight line over twelve months, so a fund that raises money over its first year loads most of the cost onto its earliest investors. On an illustrative 3.0 million of offering costs, a fund launching with 60.0 million and raising 20.0 million a month, the launch investors bear 1.314 million, 43.8 per cent of the costs, or 218.9 basis points of their investment, while anyone subscribing after month 12 bears nothing.
Worked in full in The Evergreen Fund Handbook by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Offering costs are the costs of registering and marketing shares: legal work on the prospectus, filing fees, printing, the cost of setting up distribution. Organisation costs, the costs of forming the fund itself, are expensed as incurred. For an investment company with a continuous offering, US GAAP spreads offering costs over the first twelve months of operation; a closed-end fund that sells its shares once charges them against paid-in capital instead. Other frameworks differ, and some European funds amortise set-up costs over up to five years where their accounting rules and documents allow. Check the policy with the fund's auditor before modelling it.
A straight-line charge is a fixed amount each month. In a fund that is growing, that fixed amount is a large percentage of a small NAV at the start and a small percentage of a large NAV at the end. The investors present in month 1 pay the most per euro invested, even though the offering was set up for everyone who will ever buy.
| Input | Value |
|---|---|
| Offering costs, deferred at launch | 3.0 |
| NAV at launch | 60.0 |
| Net subscriptions, received at each month end | 20.0 |
| Amortisation period, straight line | 12 months |
| Investment return | Ignored, to isolate the cost |
Monthly charge = offering costs ÷ 12 = 0.25
Charge borne by a cohort in month m = monthly charge × cohort capital ÷ NAV in month m
Cohort burden = sum over the months it is invested and the charge is running
Excel, launch cohort: =SUMPRODUCT(0.25*60/NAV_range) over months 1 to 12
Step 1, the charge. 3.0 over twelve months is 0.25 a month.
Step 2, the NAV it falls on. NAV is 60 in month 1 and 280 in month 12, so the same 0.25 is 41.7 basis points of NAV in month 1 and 8.9 in month 12. In the first month alone, NAV per share falls 0.42 per cent from the charge, a 5.0 per cent annualised drag on a fund that may be marketed on an 8 per cent target.
Step 3, each cohort's share. The launch investors own all of the fund in month 1, 75 per cent in month 2 and so on down. Summing their share of each month's charge gives 1.314, 43.8 per cent of the total, on 60.0 of capital.
| Cohort | Capital | Cost borne | Basis points of capital |
|---|---|---|---|
| Launch | 60.0 | 1.314 | 218.9 |
| Subscribed at end of month 1 | 20.0 | 0.355 | 177.3 |
| Subscribed at end of month 6 | 20.0 | 0.133 | 66.7 |
| Subscribed at end of month 11 | 20.0 | 0.018 | 8.9 |
| Subscribed at end of month 12 or later | 20.0 | 0.000 | 0.0 |
| All cohorts, including those not shown | 3.000 |
A launch investor pays almost 25 times what an investor arriving in month 11 pays, per euro, for the same offering.
| Treatment | Launch cohort bears | Share of the costs | Basis points of its capital |
|---|---|---|---|
| Charged in full at launch | 3.000 | 100% | 500.0 |
| 12 months, raising 5.0 a month | 2.143 | 71.4% | 357.2 |
| 12 months, raising 20.0 a month (case) | 1.314 | 43.8% | 218.9 |
| 12 months, raising 50.0 a month | 0.849 | 28.3% | 141.5 |
| 36 months, raising 20.0 a month | 0.682 | 22.7% | 113.7 |
| 60 months, raising 20.0 a month | 0.482 | 16.1% | 80.3 |
The slower the fund raises, the more the first investors pay. A useful benchmark of a fair share is each cohort's share of the capital the fund will hold over, say, five years. The launch cohort holds 9.2 per cent of the fund's capital-months over 60 months on this path, a fair share of 0.277, 46.2 basis points. Even a 60-month amortisation charges it 1.74 times that, and the twelve-month rule charges it almost five times.
Treating offering costs as a rounding item because they are small against the fund's eventual size. Against eventual size they are: 3.0 on a fund heading for 300 is 1 per cent. But they are charged against the size the fund has while it is being amortised. Seed and launch investors who negotiated a fee discount can lose it entirely through this one line. The usual remedies are for the manager to bear offering costs, or to include them in an expense cap with a recoupment right, which changes who pays again, as worked in how expense support recoupment works in an evergreen fund.
Seed investors should ask for the offering cost budget, the amortisation policy and a projection of the monthly charge against the expected NAV path before they commit, and negotiate a cap on the costs the fund bears in its first year.
The Evergreen Fund Handbook covers the design, liquidity, valuation, fairness and distribution of semi-liquid funds; the free workbook for this case sets evergreen returns against drawdown IRRs on the same capital. For how a new fund's cash affects returns in the same months, see how much cash drag new subscriptions cause in an evergreen fund.
Organisation costs form the fund and are expensed as incurred. Offering costs register and market the shares, and a continuously offered fund under US GAAP amortises them over twelve months. In the illustrative case, 3.0 million of offering costs is a charge of 0.25 million a month, 41.7 basis points of NAV in month 1.
Far more than their share of the fund's life. In the illustrative case the launch cohort bears 1.314 million of 3.0 million, 218.9 basis points of its capital. If the fund raises only 5.0 million a month it bears 2.143 million, 357.2 basis points. Charged in full at launch, it would bear 500.0 basis points.
Fairer, not fair. Over 60 months the illustrative launch cohort bears 80.3 basis points instead of 218.9, against a fair share, by capital held over five years, of 46.2. The cleaner fixes are for the manager to bear offering costs or to cap what the fund bears in its first year.
This article is one calculation from The Evergreen Fund Handbook. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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