Definition — what a commingled fund is
– A commingled fund pools money from multiple institutional accounts into one professionally managed portfolio. Investors’ assets are combined (commingled) to capture scale benefits and then allocated to each participant according to agreed terms. These vehicles are commonly used by pension plans, insurance portfolios, and other workplace or institutional plans.
How commingled funds differ from mutual funds (key contrasts)
– Regulation and disclosure: Mutual funds are registered with the U.S. Securities and Exchange Commission (SEC) and must follow the Investment Company Act of 1940 and public disclosure rules. Commingled funds are typically not SEC-registered and have lighter public reporting obligations.
– Fees and marketing: Commingled funds usually do not charge 12b-1 marketing fees and often
and often have lower marketing and distribution fees. That can make commingled vehicles cheaper on an ongoing basis for large institutional investors.
– Minimums and investor eligibility: Mutual funds are broadly available to retail investors and often have low minimum investments. Commingled funds typically require larger minimums and are limited to qualified institutional investors (for example, pension plans, insurance companies, and other large tax-exempt or fiduciary investors). “Qualified investor” criteria vary by vehicle and jurisdiction.
– Liquidity and access: Mutual funds usually offer daily liquidity for shareholders (subject to fund rules). Commingled funds may offer less frequent valuation and redemption windows (weekly, monthly, or with advance notice), since they optimize trading and operational efficiency for large, stable capital pools.
– Transparency and reporting: Mutual funds must provide regular public disclosures (prospectuses, shareholder reports, daily NAVs) under the Investment Company Act of 1940. Commingled funds typically disclose less publicly; reporting is usually provided only to participants under the fund’s governing documents and is governed by bank, trust, or ERISA fiduciary rules rather than SEC mutual-fund disclosure rules.
– Investment flexibility and customization: Commingled funds often allow greater customization (for example, tax-aware share classes, negotiated fee schedules, or separate account overlays for participants). Mutual funds generally offer a single, uniform product for all investors.
– Governance and oversight: Mutual funds have boards of directors and are subject to specific SEC governance rules. Commingled funds are typically governed by the sponsoring bank/trust or an advisory agreement; oversight can include bank regulators, the sponsor’s fiduciary obligations, and participant-level governance under ERISA for retirement-plan investors.
Worked example — fee drag over time
Assume an institutional investor has $1,000,000 invested for 10 years. Gross annual return (before fees) is 6.0%.
– Mutual fund expense ratio = 0.75% per year.
– Commingled fund fee = 0.40% per year.
Net annual return (approximate) = gross return − fee.
– Mutual fund net = 6.00% − 0.75% = 5.25% → Future value ≈ 1,000,000 × (1.0525)^10 ≈ $1,668,000.
– Commingled fund net = 6.00% − 0.40% = 5.60% → Future value ≈ 1,000,000 × (1.056)^10 ≈ $1,725,000.
Difference after 10 years ≈ $57,000 in favor of the lower-fee commingled fund, holding all else equal. Formula used: FV = PV × (1 + r − f)^n, where PV = present value, r = gross return, f = annual fee, n = years. Assumes fees are taken out of returns and returns are constant—real-world results vary.
Practical checklist for evaluating a commingled fund
1. Legal structure and regulatory oversight: Is the vehicle a collective investment trust (CIT), common trust fund, or another pooled vehicle? Which regulators and statutes apply?
2. Eligibility and minimums: Who may invest, and what are minimums and onboarding requirements?
3. Fees and fee schedule: Management fee, performance fees, administrative fees, and any negotiated breaks for large participants.
4. Liquidity and redemption terms: Notice periods, gating provisions, and valuation frequency.
5. Custody and safekeeping: Who is the custodian? Is the custodian independent from the sponsor?
6. Governance: Who is the trustee, what voting rights or governance provisions exist, and how are conflicts of interest handled?
7. Reporting and audits: Frequency and type of performance reports, audited financial statements, and valuation policies.
8. Service providers: Investment manager, administrator, auditor, and legal counsel—check credentials and track records.
9. Performance and benchmarking
9. Performance and benchmarking (continued)
– Compare gross vs net returns. Gross return excludes manager fees; net return is after all fees and expenses and is what investors receive.
– Check the benchmark: Is it an appropriate index (e.g., a broad bond index for fixed-income strategies, or a relevant commodity/commodity index for commodity strategies)? A mismatch can mislead about relative skill.
– Look at risk-adjusted measures: Sharpe ratio (excess return per unit of volatility), Sortino ratio (downside risk focused), and maximum drawdown. These help separate volatility from skill.
– Watch for smoothing and valuation timing. Illiquid holdings can produce smoothed returns that understate true volatility.
– Beware of survivorship and selection bias in track records. Ask for a full, unedited track record with explanation of any removed periods or funds.
– Define performance terms in the agreement: hurdle rate (minimum return the manager must achieve before collecting performance fees), high-water mark (ensures managers don’t collect incentive fees for recovering prior losses), and how carry/allocations are calculated.
10. Tax considerations
– Understand the tax wrapper: Is the vehicle a tax-transparent partnership (investors receive K‑1s) or a corporate/nontransparent entity (investors receive 1099s or equivalent)? Tax reporting timing and forms differ.
– Withholding and cross-border issues: Non-U.S. investors may face withholding taxes or treaty issues; determine the fund’s tax reporting and gross-up policies.
– Look for embedded taxable events: frequent redemptions, in-kind distributions, or realized gains in the portfolio can generate taxable income even if NAV falls.
– Ask for historical tax allocations and a sample K‑1/1099 if available. Confirm the manager’s tax provider and any tax-optimization policies.
11. Legal structure and liabilities
– Identify the legal form (e.g., limited partnership, limited liability company, trust, or commingled trust). Each has different investor protections and governance norms.
– Check fiduciary duties: Does the manager have a statutory duty of care and loyalty, or are duties limited contractually?
– Look for indemnification clauses and limits on manager liability. Note any broad exculpation provisions.
– Review transferability and assignment rules for investor interests and provisions for adding or removing investors.
12. Valuation policies and NAV (net asset value)
– NAV: the per-share or per-unit value of the fund’s assets minus liabilities, used for subscriptions and redemptions.
– Confirm valuation frequency (daily, monthly, quarterly) and methods for illiquid or private assets (independent pricing vendor, mark-to-model).
– Check for swing pricing or dilution adjustments that protect long-term investors from trading costs induced by large flows.
– Ask for valuation committee composition, valuation policy document, and examples of fair-value adjustments.
13. Risk management and limits
– Understand written risk limits (position size, leverage limits, concentration limits) and whether they are hard limits or guidelines.
– Ask for risk monitoring metrics: value at risk (VaR), stress tests, liquidity coverage ratios, and scenario analyses.
– Inquire about margining, counterparty exposure, and collateral policies if derivatives are used.
– Confirm independent risk oversight—does an independent risk officer or committee exist?
14. Operational, compliance, and cybersecurity controls
– Operations: review trade settlement processes, reconciliation frequency, and back-office staffing/outsourcing.
– Compliance: request the compliance manual, recent regulatory examination letters, and a record of past violations or enforcement actions.
– Cybersecurity: obtain the cybersecurity policy, third-party penetration test results (if available), and incident response plans.
– Anti-money laundering (AML) and KYC: confirm investor onboarding controls and ongoing monitoring processes.
15. Liquidity, redemption mechanics, and contingency planning
– Redemption terms: notice period, gates (limits on redemptions during stress), side pockets (segregation of illiquid assets), and redemption fee structures.
– Suspension and liquidation: review clauses outlining when the manager can suspend redemptions, terminate the fund, or effect wind‑down.
– Transfer restrictions: check whether investor interests can be sold, and what consents are required.
– Contingency planning: ask for examples of past liquidity events and how they were handled.
Due-diligence document checklist (ask for these)
– Offering memorandum / private placement memorandum (PPM)
– Limited partnership agreement (LPA) or operating agreement
– Investment management agreement (IMA)
– Subscription documents and investor onboarding materials
– Historical audited financial statements (3–5 years if available)
– Detailed monthly NAV and performance reports (full track record)
– Valuation policy and examples of fair-value workpapers
– Administrator and custodian agreements
– Compliance manual, AML/KYC policies, and cybersecurity policy
– Service-provider due diligence reports and insurance certificates (e.g., E&O/cyber)
Worked numeric example: fees and net investor return
Assumptions:
– Starting investor capital: $1,000,000
– Management fee: 1.00% per year (charged on AUM)
– Performance fee: 20% of profits above a 5.00% annual hurdle, with a high‑water mark
– Year 1 gross return: 12.00%
Step 1 — gross profit: $1,000,000 × 12% = $120,000
Step 2 — management fee: $1,000,000 × 1% = $10,000
Step 3 — net of management fee before performance: $1,000,000 + $120,000 − $10,000 = $1,110,000
Step 4 — performance fee calculation:
– Hurdle amount = 5% of $1,000,000 = $50,000
– Profit above hurdle = $120,000 − $50,000 = $70,000
– Performance fee = 20% × $70,000 = $14,000
Step 5 — investor ending capital = $1,110,000 − $14,000 = $1,096,000
Step 6 — investor net return = ($1,096,000 − $1,000,000) / $1,000,000 = 9.6%
Notes: If a high‑water mark applied and the investor had prior losses to recover, performance fee timing would change. Also some funds compute