An expense cap moves a new fund's costs in time, from its first investors to the ones who arrive later.
The manager pays the fund's operating expenses above a cap while the fund is small, and takes the money back later, out of the fund, in years when expenses fall below the cap, usually within three years of each waiver. On an illustrative fund with a 0.75 per cent cap, the manager absorbs $2.000M over the first two years and recoups all of it in years three and four: the launch investors save 245 basis points, and the investors who arrive later pay 15 and then 20.
Worked in full in The Evergreen Fund Handbook by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A new semi-liquid fund has fixed running costs (administration, audit, legal, transfer agency, directors, reporting) and very little NAV to spread them over. Without help, the first investors would see an expense ratio several times the long-run figure, and the fund would be unsellable. So the manager signs an expense limitation or expense support agreement: it waives or reimburses specified operating expenses above a cap, expressed as a percentage of average net assets. Management and incentive fees, interest, taxes and extraordinary items are normally carved out of the cap.
The support is usually not a gift. In US registered funds, following the SEC staff's long-standing position, and in many similar agreements, the manager can recoup amounts it has paid, provided two conditions hold: the recoupment happens within a fixed window, typically three years after the year of the waiver, and the fund's expense ratio after recoupment stays below the lesser of the cap in force when the waiver was made and the cap in force when it is recouped. In other words, recoupment can only use headroom under the cap. It never pushes investors above it.
| Year | Average NAV | Specified operating expenses | Expense ratio before support |
|---|---|---|---|
| 1 | 50.0 | 1.60 | 3.20% |
| 2 | 150.0 | 1.90 | 1.27% |
| 3 | 400.0 | 2.40 | 0.60% |
| 4 | 700.0 | 2.90 | 0.41% |
| 5 | 900.0 | 3.20 | 0.36% |
The cap is 0.75 per cent of average NAV throughout, and waivers can be recouped within three years after the year in which they were made, oldest first.
Cap amount = cap × average NAV
Waiver = MAX(0, expenses − cap amount) Excel: =MAX(0,C2-$B$9*B2)
Headroom = MAX(0, cap amount − expenses)
Recoupment = MIN(headroom, waivers still inside their window)
Year 1. The cap allows 0.375 on 50.0 of NAV. Expenses are 1.60, so the manager waives 1.225. Investors bear 0.75 per cent instead of 3.20.
Year 2. The cap allows 1.125; expenses are 1.90; the manager waives 0.775. Outstanding support: 2.000.
Year 3. The cap allows 3.000 and expenses are 2.40, leaving 0.600 of headroom. The manager recoups 0.600 of the year-1 waiver. Investors still bear exactly 0.75 per cent, but 15 basis points of it is year 1's costs.
Year 4. The cap allows 5.250 against 2.90 of expenses, 2.350 of headroom. The manager recoups the remaining 1.400: 0.625 of the year-1 waiver, inside its window, and all 0.775 of year 2. The fund bears 4.300, 0.61 per cent rather than 0.41.
| Year | Cap amount | Waived | Recouped | Borne by the fund | Ratio borne | Outstanding at year end |
|---|---|---|---|---|---|---|
| 1 | 0.375 | 1.225 | 0.000 | 0.375 | 0.75% | 1.225 |
| 2 | 1.125 | 0.775 | 0.000 | 1.125 | 0.75% | 2.000 |
| 3 | 3.000 | 0.000 | 0.600 | 3.000 | 0.75% | 1.400 |
| 4 | 5.250 | 0.000 | 1.400 | 4.300 | 0.61% | 0.000 |
| 5 | 6.750 | 0.000 | 0.000 | 3.200 | 0.36% | 0.000 |
| Total | 2.000 | 2.000 | 12.00 |
Over five years the fund bears all 12.00 of its expenses, 0.545 per cent of the NAV it carried. The manager has only moved them in time, and the move is a transfer between investors. A year-1 investor saved 245 basis points on a year when it was one of very few holders. The 15 and 20 basis points recouped in years 3 and 4 fall on everyone holding then, and, ignoring returns and redemptions, investors who arrived after year 1 hold about 87.5 per cent of year-3 NAV and 92.9 per cent of year-4 NAV. That is the design working as intended, since the fund needed early capital, but it is a fairness question the board should see quantified, in the same way as the dilution effects in how a stale NAV dilutes investors in a semi-liquid fund.
| Path | NAV in year 5 | Waived | Recouped | Expired | Still recoupable |
|---|---|---|---|---|---|
| Fast | 1,200.0 | 1.225 | 1.225 | 0.000 | 0.000 |
| Case | 900.0 | 2.000 | 2.000 | 0.000 | 0.000 |
| Slow | 260.0 | 6.450 | 0.000 | 1.225 | 5.225 |
If the fund raises quickly, the manager's support is small and comes back within two years. If it raises slowly, the expense ratio before support stays above the cap, nothing is recouped, the year-1 waiver of 1.225 lapses at the end of year 4, and 5.225 is still hanging over the fund at the end of year 5. That overhang matters to a new investor: as soon as NAV grows, up to 5.225 can flow back to the manager before investors see any economies of scale.
Reading the capped ratio as the fund's cost, or the gross ratio as the investor's. In year 1 the expense ratio before support is 3.20 per cent and investors pay 0.75; in year 4 the gross ratio is 0.41 and investors pay 0.61. Ask for both columns and for the amount still subject to recoupment, with the year each piece expires. A fund that discloses only the net ratio is reporting the cap, not the cost.
Check the definition of the cap as closely as its level. Whether it covers organisation and offering costs, servicing fees or the costs of a credit facility changes both what is waived and how much headroom later years have for recoupment.
The Evergreen Fund Handbook covers the design, liquidity, valuation, fairness and distribution of semi-liquid funds; the free workbook for this case compares evergreen and drawdown returns on the same footing. For how fund costs compare once the fund is mature, see whether evergreen fund fees are lower than closed-end fees.
No. Recoupment is usually limited to the lesser of the cap at the time of the waiver and the cap at the time of recoupment. In the illustrative case, year 3 has 0.600 million of headroom under a 0.75 per cent cap, so only 0.600 is recouped, and the fund still bears exactly 0.75 per cent.
It expires at the end of the window and the manager absorbs it. On an illustrative slow growth path reaching only 260.0 million of NAV, the 1.225 million waived in year 1 lapses after year 4, and 5.225 million from later years is still recoupable, which can flow back to the manager as soon as NAV grows.
Everyone holding the fund when it is recouped, mostly investors who arrived after the waiver. In the illustrative case launch investors save 245 basis points in year 1, while the 15 and 20 basis points recouped in years 3 and 4 fall on a NAV that is about 87.5 and 92.9 per cent later money, ignoring returns and redemptions.
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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