As investors make fresh equity allocations for 2021, they have a wealth of choices, especially eiyh alternative assets. It was about time for someone to ask me to compare the costs of investing in mutual funds or PMS vs. VC
Yesterday, I pitched 3 family offices to invest in our fund. Oddly enough, I got the same question in each of those pitches that did not get asked while raising more than 80% of our fund.
How do your management fees compare to the management fees of a mutual fund or a PMS?
While I explained that VC fund management fees are several times lower than that of a mutual fund, I had to prepare a quick excel to show the difference. On the surface, an equity Mutual Fund, PMS, or VC fund charges about the same fee range, i.e., between 1 to 2% of the assets under management. However, the big difference is how a Mutual Fund or PMS manager defines its assets under management (AUM) versus the VC fund manager.
The VC fund manager defines their AUM as the amount invested by the investor, i.e., if you commit ₹1000, then throughout that fund’s life, the AUM on which they calculate the management fee remains ₹1000.
For the Mutual Fund or PMS manager, the AUM definition is the current market value of your investment when they levy their fee. Therefore, if your investment is marked up 40%, the Mutual Fund or PMS manager’s fees will be charged on ₹1400 and not on the original investment. Those numbers add very quickly for a long term investment and could be eye-popping on an apples to apples comparison.
Assuming a 30% IRR over the fund life, the management fee paid in the 10th year for an equity MF generating 30% IRR is 20% of the original investment!
The same fee would continue to be 1.50% for a VC fund.*
|Year||Investment Amount||Mutual Fund / PMS||VC Fund|
|Mutual Fund / VC Fund||5.54x|
The better the fund performs, the more the MF manager takes every year, regardless of whether they are selling or holding their position. On the flip side, the VC fund manager takes a profit share only AFTER they have sold their investments and return the principal plus a hurdle rate to the investor. Therefore, mutual funds can argue that they are a less volatile investment option (although there anecdotal evidence that they are not) in comparison to VC funds.
However, they are by no means “cheaper” for investors.
I made a simple worksheet for showing the difference in fees. You can access it here.
*in most cases, it is lower as the management fee gets calculated on the net value remaining in the fund, i.e., the principal amount minus the exits or write-offs)