Fund Audits: What Businesses Need to Know

• Auditing and Assurance
• ||
• February 12, 2025

Do you know how investors grow their wealth through investments?

It might seem tricky, but it’s actually quite simple! Investors allocate their money to financial products that offer potential returns over time.

So, what are the options? There are various financial assets like equities, debt instruments, and government bonds. Investors build a portfolio by investing in these assets in different proportions. To optimize returns, many investors rely on fund managers who strategically manage their funds and portfolios.

So whether you are a fund manager, investor, or industry professional, understanding the fundamentals of different fund types, their regulatory requirements, and especially the importance of fund audits is crucial for success in this industry.

In order to know more about fund audits, first, we need to understand what exactly a fund is and what the different types of funds are.

What is a Fund?

A fund is a sum of money collected from investors that is allocated in different financial assets (such as debt, equity, Govt. securities and bonds, etc.)  for a specific purpose under a specific scheme such as retirement, insurance, or endowments and managed by a Fund Manager working under a wealth management company.

In other words, a fund is like a financial team. You and other investors contribute to a shared pool of money. A Fund Manager acts as a coach, making smart investment decisions in different areas (like stocks and bonds) to help you reach your goals, whether they’re retirement, insurance, or something else.

Purpose of a Fund

The primary purpose of a fund is to help investors in earning an income or building their wealth by investing in the opportunities available in securities markets.

Funds serve distinct purposes based on their structure and objectives. Here are some examples:

• Emergency Funds: Provide financial security during unexpected situations.
• Investment Funds: Pool capital from investors to generate returns through strategic asset allocation.
• College Funds: Help parents save for their children’s future education.
• Pension Funds: Ensure long-term financial security for retirees.

Types of Funds

Funds come in various forms, each designed to meet investors’ specific financial goals. These funds offer a cost-effective way for investors to gain broad market exposure with minimal management fees.

Here are some of the most common types:

1. Mutual Funds: A Mutual Fund is a professionally managed investment vehicle (a “trust”) that mobilizes money from investors to invest in different markets and securities across various asset classes (stocks, bonds, and short-term debt instruments) offered by an asset management company.
2. Index Funds: Fund managers track a particular fund and then manage to put their securities according to the performance of that Index. Bought and sold at the end of each trading day. They are the type of passive funds (track the performance of a particular market index) such as the S&P 500.
3. Exchange-traded funds (ETFs): These are also passive funds, tracking an index, commodity, bond, or basket of assets. Still, unlike index funds, they are traded on stock exchanges like common stock exchanges like Common stocks, providing liquidity and flexibility to investors.
4. Hedge Funds: Hedge funds are alternative investment funds that employ diverse or complex trading strategies. They invest in and trade securities with diverse risks or complex products, including listed and unlisted derivatives.
5. Private Equity Funds (PE): Private equity funds invest primarily in equity or equity-linked instruments of private companies or acquire public companies to restructure and enhance their value. Mostly involved in later-stage financing in business entities that have established a business model and need to be scaled up for further growth.
6. Other Types of Funds: Investment funds extend beyond traditional vehicles and include:

• • Target date and target allocation funds – Designed to adjust asset allocation over time based on an investor’s retirement timeline.
  • Money market funds – Low-risk funds investing in short-term, high-quality debt instruments.
  • Real estate investment trusts (REITs) – Funds that invest in income-generating real estate properties.
  • Pension funds – Funds designed to provide retirement income to employees.
  • Insurance funds – Pooled reserves used by insurance companies to meet policyholder claims.
  • Foundations and endowments – Funds established for charitable, educational, or philanthropic purposes.
  • Angel funds, venture capital funds, SME funds, etc.

Fund Manager Guide 

Launching a new investment fund—whether a hedge fund, private equity fund, or venture capital fund—requires making critical decisions and absorbing a wealth of information. Key considerations include selecting the optimal tax structure, determining management fees, and identifying the best investment opportunities to maximize investors’ returns.

Starting an investment fund requires careful planning, regulatory compliance, and strategic fundraising. Below are the key steps to establish a successful fund:

1. Gain Professional Expertise – A strong background in investment management is essential to attract investors and manage the fund effectively.
2. Choose the Fund Type – Decide whether to establish a hedge fund, private equity fund, or venture capital fund, each with different structures and risk profiles.
3. Incorporate and Establish a Legal Framework

1. • Form a legal entity (LP or LLC).
   • Draft key documents like the Limited Partnership Agreement (LPA) and Private Placement Memorandum (PPM).
   • Register with relevant regulatory bodies (e.g., SEC in the U.S.).
2. Develop an Investment Strategy – Define asset classes, risk tolerance, expected returns, and liquidity terms that align with investor goals.
3. Raise Capital – Market the fund to potential investors, including institutional investors, family offices, and high-net-worth individuals.
4. Hire Key Staff and Service Providers
   • Fund Managers, Compliance Officers, and Investor Relations teams.
   • Outsource fund administration, legal counsel, and audit services.
5. Launch the Fund – Start executing the investment strategy while maintaining investor transparency and trust.
6. Ongoing Management & Compliance – Regular audits, financial reporting, and regulatory compliance ensure fund credibility and investor confidence.

Why does the fund need to be audited? 

A Fund audit is a detailed examination of a fund’s financial records in order to ensure accuracy, compliance, and transparency. It verifies whether the fund’s income, expenses, and investments are properly recorded and managed according to legal, regulatory, and financial standards.

Key Reasons for Conducting Investment Funds:

1. Ensuring compliance with LPA: A fund audit is conducted to verify that the fund’s GPs (general partners) are operating in accordance with LPA (limited partnership agreement) and that the financial statements accurately reflect this compliance. A clean audit reassures LP (Limited Partners) that the fund is being managed in accordance with the agreement. Many start-up funds initially opt out of financial statement audits to minimize costs. However, depending on factors such as the types of investors they aim to attract or have already secured, some funds include an audit requirement in their LPA—typically with a 90-day or 120-day deadline.
2. Validating Investment Valuations: An audit ensures that an independent public accountant/accounting firm has verified the fund’s financial statements and reported performance, assuring investors that mutual funds, venture capital, and private equity funds do not generate immediate returns. Instead, they report the estimated value of their assets.

3. Regulatory Requirements: The Securities and Exchange Commission (SEC) serves as the primary regulator for investment companies and advisers in the U.S. The SEC’s Custody Rule requires investment advisers who have custody of client assets to undergo an annual audit by an independent public accountant.
   

4. Investor Expectations: Institutional investors, such as pension funds, insurance companies, and endowments, often require audited financial statements before committing capital. Even if a fund’s LPA does not mandate an audit, investor demands may prompt the fund manager to conduct one.
5. Compliance with Fund Documents: Fund managers must ensure compliance with all legal and operational documents, including:

6. Preparing for Future Fundraising: Efficient and Effective Financial planning of funds helps to raise additional capital, which ultimately requires an audit to establish the credibility of potential Investors. most importantly, Audited financials ensure that fund managers operate transparently and in compliance with regulations.

The Fund Audit Process

A fund audit involves independent verification of financial statements to ensure accuracy, transparency, and regulatory compliance. The key steps include:

1. Engagement Planning: Auditors conduct engagement planning, which includes understanding the client’s business and industry, determining materiality levels and thresholds, developing the audit strategy, and planning audit procedures.
2. Evaluation of Internal Controls: The auditor examines the fund’s internal control to identify potential weaknesses that may lead to errors or fraud.
3. Investment Valuation Testing: Hedge funds and Private Equity often hold complex and illiquid investments, such as derivatives and private equity interests. The auditor will test the valuation of these investments to ensure they are fair and accurate and in accordance with Generally Accepted Accounting Principles (GAAP).

4. Review of Regulatory Compliance: Funds must adhere to regulations governing investment strategies, leverage, and disclosures. Auditors verify compliance with all applicable rules.
5. Examination of Financial Statements: Auditors review the following:

• • Balance sheets
  • Income statements
  • Cash flow statements
  • Schedule of investments

6. Testing of Key Financial Metrics

Key Documents Required for a Fund Audit

In order to conduct a thorough audit, auditors require the following documents :

• Fund foundation-level documents, including the Limited Partnership Agreement (LPA)
• Operating agreements and partner agreements.
• Subscription documents and side letters
• EIN letter issued by the Internal Revenue Service (IRS)
• Articles of incorporation
• Statement of assets, liabilities, and partners’ capital
• Statement of changes in partners’ capital
• Bank account and brokerage account statements
• Schedule of portfolio investments
• Service agreements with third parties, including fund administrators, auditors, and legal advisors
• Expense invoices related to fund operations
• Statement of cash flows, including investor capital contributions, distributions, and carried interest calculations.

Whom Do We Need To Consult?

In India, a Practicing Chartered Accountant (CA) or a CA Firm registered under the Institute of Chartered Accountants of India (ICAI) is authorized by Indian law to perform audit services for funds.

In the USA, a firm registered under the Public Company Accounting Oversight Board (PCAOB) is authorized to perform audit services for funds.

At Mercurius, we understand the sophistication of investment funds. Our professional fund auditors have extensive knowledge of financial instruments and industry practices. We, Mercurius & Associates LLP,  are a PCAOB-registered firm and are also registered under the Institute of Chartered Accountants of India (ICAI), which helps you conduct effective audits.

Conclusion

Fund audits increase transparency, Investor trust, and regulatory compliance. Independent verification of all financial data ensures that Investors receive accurate information in order to make informed investment decisions; building investors’ trust will let your fund management company touch the heights of glory.

We, Mercurius & Associates LLP, are a PCAOB-registered firm. We also assist our clients with internal audits, statutory audits (USGAAP audits), government audits, Bank audits, and various corporate matters (Company incorporation, ROC compliance, Company winding-up) worldwide by providing them with adequate support and guidance.

If you have any questions or would like to know more about the benefits and why the company needs to be audited, please contact us.