Calculating gross and net investment performance should be simple, right? Yes, however, firms often face fee-related portfolio accounting or administrative issues that cause complications, resulting in inaccurate performance. It is essential that all types of fees are accounted for correctly to ensure reported performance can be relied upon and properly evaluated by clients and prospective investors.
Which Fees and Expenses Reduce Investment Performance?
Gross-of-fee performance represents a portfolio’s return net of
transaction costs only. Net-of-fee performance is net of transaction
costs and investment management fees, so the only difference between
gross and net performance is the investment management fee. According to
the Global Investment Performance Standards (GIPS®), investment
management fees are defined to include both asset-based and
performance-based fees that are earned for managing a portfolio.
If your firm is GIPS compliant, it is important to reduce performance
by both types of fees when calculating net-of-fee performance. For
non-GIPS compliant firms, this is still considered a best practice;
however, it is common for firms with both types of fees to report
performance reduced only by the asset-based fee as “Net” and performance
reduced by both the asset-based fee and performance-based fee as “Net
Administrative fees, such as custody fees, do not reduce performance.
This is the typical practice because clients have some control over
selecting a custodian and, therefore, the administrative fees charged to
their portfolio. For this reason, administrative fees are excluded from
performance calculations and instead are treated like external cash
flows that do not reduce their return.
The most common exception to this is net performance reported for mutual funds, which is typically calculated based on the change in the fund’s net asset value (NAV), resulting in performance that is net of all fees and expenses. Mutual fund investors do not have control over the custodian used or administrative fees charged (i.e., the manager selects the custodian), so these fees do reduce performance when calculating net returns for mutual funds.
What Are the Most Common Fee-Related Administrative Issues and How Can They Be Addressed?
The most common administrative issues that affect performance results usually are derived from:
- Clients paying their management fee by check or from another outside source
- Accounts with bundled fee structures (e.g., wrap accounts)
- Accounts paying asset-based fees for transactions in lieu of per-trade commissions
We will examine each of these issues below.
1. Clients Paying Their Management Fee by Check or from Another Outside Source
In an ideal world all clients would have their management fees
directly debited from the account that earned the fee; however, this is
not always the case. Some clients prefer to pay their management fees by
check or out of one of their multiple accounts managed by your firm.
Since many firms record their accounts receivable in an accounting
system separate from their portfolio accounting system (which calculates
performance), a matching entry must be added to the portfolio
accounting system when fees are paid. If this fee is not recorded in the
portfolio accounting system, the client’s gross and net returns will be
equal (neither being reduced by the management fee), which is
How to Add Adjusting Accounting Entries to Ensure Net-of-Fee Performance Is Accurate
When a client pays their fee by check, to correctly record this, two entries are needed in the portfolio accounting system:
- An external cash inflow matching the management fees paid by check.
- A management fee expense for the same amount.
After these two transactions are made, the portfolio’s market value
will be the same as it was before entering these transactions since the
two transactions offset each other. While these entries do not change
the value of the portfolio, an expense is recorded that will allow the
system to report the correct net-of-fee performance for the period.
Similarly, when the management fee is directly debited from another
account, adjustments need to be made to both the account that paid the
fee and the account that earned the fee. The account that paid the
management fee will need two accounting entries:
- A negative management fee expense for fees paid on behalf of a different account.
- An external cash outflow for the same amount.
The account that earned the management fee will also need two
accounting entries (note that these are the same as the entries when
paid by check):
- An external cash inflow matching the fees paid by the other account.
- A management fee expense for the same amount.
Again, these transactions will not change the market value of any
account as these entries simultaneously adjust cash and management fee
expense by the same amount. While this has no effect on the total
portfolio’s market value, it will allow net-of fee performance to be
accurately reported, regardless of the source or method of the actual
Forgetting to make these adjustments is very common and often leads
to erroneously overstating net-of-fee performance for clients paying
their fees from an outside source. It will also result in an
overstatement of net-of-fee performance for any composite that includes
these accounts. To avoid regulatory deficiencies or non-compliance with
GIPS requirements, it is best to look into whether your firm has
accounts paying management fees from outside sources and ensure proper
adjustments are made.
2. Accounts with Bundled Fee Structures, Such as Wrap Accounts
As previously discussed, gross-of-fee performance is reduced by
transaction costs and net-of-fee performance is reduced by transaction
costs and management fees. This can become complicated when fees and
expenses are bundled together and accounted for as one bundled fee.
What to Do If Fees and Expenses Are Bundled Together and Cannot Be Separated
If fees and expenses cannot be separated, gross-of-fee performance is
calculated by reducing performance by transaction costs and any fees or
expenses that cannot be separated from those transaction costs.
Net-of-fee performance is then calculated by reducing performance by
transaction costs and management fees, as well as any fees or expenses
that cannot be separated from the transaction costs or management fees.
This often results in identical gross-of fee and net-of-fee performance,
as both performance measures are reduced by the entire bundled fee.
This most commonly occurs with wrap accounts, where the client pays
one bundled fee and the individual fees for transaction costs,
management fees, etc. cannot be separately determined. When this occurs,
disclosures should be included with the performance to clarify if any
fees other than transaction costs and management fees have been used to
Alternative Presentation Options for Gross-of-Fee and Net-of-Fee Performance With Bundled Fees
Instead of presenting gross-of-fee performance that is equal to
net-of-fee performance, firms often only include net returns as their
official performance, but then also present “pure gross” returns as
supplemental information. Pure gross returns are gross of all fees and
expenses and must be disclosed as such.
3. Accounts That Pay Asset-Based Fees for Transactions in Lieu of Per-Trade Commissions
As discussed earlier, gross-of-fee performance is reduced by
transaction costs. Typically these transaction costs are the commissions
tied to each executed trade; however, there has been a trend towards
using asset-based fee structures for transaction costs, instead of
If an account is actively managed and trades frequently enough that
an asset-based fee structure results in lower expenses than paying
commissions on each trade, an asset-based fee structure may be a good
option for your client. However, properly accounting for this kind of
fee structure in your portfolio accounting system may be challenging, as
many portfolio accounting systems have not caught up with this trend,
leading to errors in the client’s reported performance.
With a commission-based structure, portfolio accounting systems
typically account for each trade net of commissions, which ensures that
gross-of-fee performance is net of transaction costs. All other fees and
expenses are recorded as separate line items that are coded as either
“performance affecting” (e.g., management fees, which reduce performance
to arrive at net-of fee-returns), or “non-performance affecting” (e.g.,
administrative fees, which are treated as external cash flows that do
not have an effect on performance).
When asset-based fee structures replace per-trade commissions, the
asset-based fee is commonly accounted for as a line item, similar to
management fees or other administrative expenses. The problem with this
is that neither of the two options available (“performance-affecting” or
“non-performance-affecting”) reduce gross-of-fee performance to account
for trading costs. Instead, these options were only designed to reduce
net-of-fee performance or reduce neither performance measure (i.e.,
there is often no transaction code that only reduces gross-of-fee
How to Make Adjustments to Properly Account for Asset-Based Transaction Costs
Many systems have not created a solution for asset-based transaction
costs, leaving firms to develop their own workarounds to reduce
gross-of-fee returns. One example of a workaround that firms use is to
record these fees as negative dividends, which results in the desired
effect of reducing gross-of-fee performance. While this approach works,
it is not ideal since the dividend transaction code is not intended to
be used for this purpose, and should only be used as a short-term
solution until your portfolio accounting system provider can offer an
appropriate transaction code that will properly account for this type of
Firms that have accounts with this type of fee structure for
transaction costs should check with their portfolio accounting system
provider to confirm if there is a way to ensure these fees are accounted
for properly. Ideally, this should be addressed with a system developer
or senior representative from your system provider, as this question is
likely beyond the knowledge of a typical helpdesk associate, and may
not be addressed in the reference materials they have available to them.
While this post is focused on fee-related administrative issues that
affect performance, there are many other fee-related issues that firms
face in reporting investment performance. We intend to cover additional
fee-related topics in future posts, including: determining whether to
use cash basis or accrual accounting for management fees, and
considerations for determining when it is appropriate to use
hypothetical or model management fees instead of actual management fees
to calculate net-of-fee performance. If you would like to receive
periodic information on these kinds of topics, please subscribe to our
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For more information on fee-related administrative issues or to
discuss other investment performance or GIPS® topics, please contact
Sean Gilligan at email@example.com.
Sean P. Gilligan, CFA, CPA, CIPM is the Managing Partner of Longs Peak Advisory Services, LLC. He has 20 years of experience in the investment industry and he specializes in GIPS compliance and investment performance consulting. Visit our website or contact us for more information on our firm and services.