Fund-of-funds structures are hardly a novelty, yet they continue to capture attention, particularly among emerging managers and wealth managers seeking to diversify exposure and accelerate growth. While the investment potential is attractive, many underestimate how the choice of investee funds can significantly shape audit complexity, operational timelines and, ultimately, investor confidence.
In an environment where speed, transparency and accuracy matter more than ever, understanding these cost drivers is not just an accounting concern, it’s a strategic advantage — for fund-of-funds managers who proactively address them.
Audit Cost Driver: Status, Timeliness and Impact of Your Investee Fund Audits
Action Item: Ensure your investee fund audits are accurate and complete prior to your fund-of-funds regulatory deadline.
An auditor may use audits of a fund-of-funds’ underlying investee funds to significantly reduce the time spent on certain substantive procedures. By using the audited financial statements of the investee funds prepared and opined on by other auditors, the primary auditor can avoid duplicating testing already performed. This allows the auditor to concentrate on higher-level procedures, such as assessing the competence and independence of the other auditors, evaluating the reasonableness of net asset values (NAVs), and performing targeted analytical reviews, thereby streamlining the audit process while maintaining audit quality.
As a result, it’s critical to ensure investee fund audits are prepared prior to the fund-of-funds’ regulatory deadline. When investee fund financial statements are available promptly, auditors can perform necessary procedures, verify valuations and address any discrepancies without delaying the fund-of-funds’ own regulatory filings.
Audit Cost Driver: Alignment of Fiscal Year-Ends
Action Item: Consider aligning year-end funds to potentially reduce costs.
Misaligned year-ends require auditors to obtain supplementary evidence to validate the NAV at your reporting date. This can add complexity and cost during already high-pressure audit windows. It’s important to understand how your year-ends may or may not impact your fund from a cost perspective to determine if aligning them is the best move.
Audit Cost Driver: Investee Fund Accounting Standards and Potential Valuation Impact
Action Item: Communicate investment implications with service providers prior to investing, if possible.
When an investee fund does not qualify for the practical expedient under ASC 820, auditors may face significant valuation challenges. For example, a fund that prepares its financial statements on a non-GAAP basis, such as income tax basis, may not meet the criteria for the practical expedient because its NAV does not represent fair value in accordance with U.S. GAAP. Without the expedient, the auditor cannot rely on the NAV reported by the investee fund and must perform additional procedures to independently assess the investment’s valuation. Challenges may include limited or delayed access to underlying portfolio information, differences in accounting policies and the need to apply alternative valuation techniques, such as discounted cash flow or market comparables. These factors increase both the complexity and time required for the audit, while also heightening judgment and estimation risk.
Audit Cost Driver: Materiality Relative to Your NAV
Action Item: Discuss substantial investments with your service providers before investing to better understand any potential financial statement/audit impacts.
A large single investment, especially in a complex vehicle, can disproportionately impact audit scope. Auditors may be required to expand the scope of testing to ensure the underlying audits of large investments were performed appropriately.
Action Steps and the Strategic Imperative for Emerging Fund-of-Funds Managers
Investing in private investment companies can open doors to otherwise inaccessible markets. But with opportunity comes operational complexity and a potentially higher bar for financial clarity. It’s important to:
- Engage early: Bring your auditors and administrators into pre-investment discussions.
- Request pro forma financials: This reduces some of the back-and-forth during the audit period.
- Document valuation approaches: The more transparent your methodology, the easier your audit and investor conversations will be.
However, the cost of complexity goes beyond audit fees — it can influence your speed to market, ability to meet investor reporting timelines, liquidity and perceived sophistication of your firm’s operation. The best managers treat audit conversations as part of their investment due diligence, engaging service providers before committing capital.
The managers who anticipate these accounting hurdles and integrate appropriate procedures into their investment strategy proactively will control costs and strengthen investor trust. In a market that rewards both performance and operational excellence, understanding your audit cost drivers provides you with a competitive edge.
Contact Colin McLaughlin, Adam Mohamed or a member of your service team to discuss this topic further.
