Acquired Fund Fees And Expenses

Marguerite reviews the fee table of Thorncroft Allocation Fund, a fund that invests entirely in other mutual funds. The table lists a 0.35% management fee, a 0.25% 12b-1 fee, and a separate line reading Acquired Fund Fees and Expenses 0.41%, for total annual operating expenses of 1.01%. What does that 0.41% line represent?

1. A.A performance fee Thorncroft's adviser earns in any year the fund beats its stated benchmarkPerformance-based compensation for a registered fund must be a symmetrical fulcrum fee and would appear inside the management fee line, not as acquired fund expenses.
2. B.Marguerite's pro-rata share of the operating expenses charged inside the underlying funds Thorncroft owns, layered on top of Thorncroft's own feesCorrect. The underlying funds deduct their own management and operating costs; Thorncroft's shareholders bear them indirectly, so the SEC requires the layer to be broken out in the fee table.
3. C.Brokerage commissions and other portfolio transaction costs Thorncroft pays to trade its holdingsTransaction costs are real, but they are not part of the expense ratio at all - they are reflected in the fund's returns and disclosed separately. This line is specifically the underlying funds' expense ratios.
4. D.A front-end sales charge Thorncroft pays to the underlying funds' distributors each time it buys their sharesThis confuses expenses with loads. A fund of funds buys underlying shares at net asset value; the line reflects ongoing operating expenses, not a one-time sales charge.

Why: A fund of funds pays the operating expenses of the underlying funds it owns, and those costs come out of the underlying funds before Thorncroft ever books a return. The SEC requires that layer to be disclosed separately as Acquired Fund Fees and Expenses so investors can see the true, all-in cost rather than only the top-layer 0.60% Thorncroft charges directly. The clue is the phrase invests entirely in other mutual funds - two layers of fees exist. Review: mutual fund characteristics, fee tables and expense ratios. Trap: the exam expects you to add the layers, not treat the top layer as the whole story.

The fee table of Halvorsen Diversified Allocation Fund, which invests by holding other mutual funds rather than individual securities, shows a 0.35% management fee and a separate line reading acquired fund fees and expenses of 0.58%. That second line represents:

1. A.the shareholder pro rata share of the operating expenses charged inside the underlying funds the portfolio holds.Correct. It is the second layer of expense in a fund of funds structure.
2. B.a one-time organisational expense amortised over the fund first five years.Organisational costs are not what this line captures, and it is not a one-time item.
3. C.an estimate of what an investor would pay if he bought the underlying funds directly instead.It is an actual cost he bears through this fund, not a comparison figure.
4. D.the sales charges the fund paid when it purchased shares of the underlying funds.A fund of funds ordinarily acquires underlying shares at net asset value; this line is about ongoing expenses.

Why: A fund of funds bears two layers of cost: its own management and operating expenses, and its pro rata share of the expenses charged inside the underlying funds it holds. The acquired fund fees and expenses line discloses that second layer so an investor can see the true all-in cost, here roughly 0.93% before any other operating expenses, rather than being misled by the 0.35% headline. The layering is exactly what a representative should surface when comparing such a fund with a single-manager alternative.

Fennimore Multi-Strategy Fund wants to build a position in Larkfield Small Cap Fund, an unaffiliated registered fund, relying on the statutory limits of Section 12(d)(1) rather than any exemptive relief. Fennimore's portfolio manager asks how large the position may get. Which combination of limits applies?

1. A.No more than 5% of Larkfield's outstanding voting shares, with no cap on Fennimore's aggregate holdings of other funds so long as the prospectus discloses the strategyDisclosure never substitutes for a statutory limit, and the aggregate 10% cap plainly exists. This choice also misassigns 5%, which is an asset-side limit.
2. B.No more than 10% of Larkfield's outstanding voting shares and no more than 25% of Fennimore's assets in acquired funds overallThe 10% here is attached to the wrong side of the test - 10% is the aggregate asset cap for the acquiring fund, and the ownership cap on the acquired fund is 3%, not 10%.
3. C.At least 75% of Fennimore's assets must be diversified, with no more than 5% in Larkfield and no more than 10% of Larkfield's voting sharesThis imports the 75-5-10 diversified-company test. That test governs whether a fund may call itself diversified; it does not govern purchases of other investment companies.
4. D.No more than 3% of Larkfield's outstanding voting shares, no more than 5% of Fennimore's assets in Larkfield, and no more than 10% of Fennimore's assets in acquired funds overallCorrect. These three statutory ceilings apply simultaneously, and Fennimore must satisfy every one of them.

Why: The statutory fund-of-funds limits are often remembered as 3-5-10. An acquiring fund may not own more than 3% of the acquired fund's outstanding voting stock; may not put more than 5% of its own total assets into any single acquired fund; and may not put more than 10% of its own total assets into acquired investment companies in the aggregate. All three bind at once, so the smallest one controls in practice. The clue is rather than any exemptive relief - the statutory ceilings apply. Review: investment company structures and fund-of-funds limits. Trap: 75-5-10 belongs to the diversification test, not the fund-of-funds test.