A CIPM candidate emailed me a question today regarding one of the exercises found in the Principles Level, in the interactive portion of the curriculum materials. This question is found in Study Session VII and is question 10:

Langerton Asset Management has complete historical information about the fees
incurred by the portfolios in the domestic large cap equity composite. Langerton
recently increased its investment management fees. To calculate net-of-fees composite
returns, Langerton must reduce the domestic large cap equity composite’s gross-offees
returns by the:

a) highest investment management fee in the current fee schedule
b) actual investment management fees incurred by the portfolios in the composite
c) highest investment management fee incurred in each period by the portfolios in the composite

The exercise indicates to select the “best” answer.

The answer is b). But why?

Here is my interpretation:

– They indicated to select the “best” answer. This is an acknowledgment that more than one answer could be correct. It is also an indication that if more than one answer is correct, in the opinion of the question writers, one of the correct answers is more valid (i.e., better) than the rest of the correct answers.

– GIPS allows compliant firms to calculate net-of-fees performance in a couple of different ways: you may reduce the gross-of-fees return by actual management fees or, alternatively, you may reduce the gross-of-fees return by model management fees.

Unfortunately, there is no guidance at this time that explains what a model management fee is. Whenever the question of what is meant by model management fee is asked of me, I say the safest thing is to use the highest management fee.

Given this, either a) or c) could be correct answers, in my opinion. Both answers provide a means of calculating a model management fee.

Having said all of this, I think it is fair to say that GIPS does not indicate a preference for the use of actual management fees over model management fees. Thus it could seem that either approach is fine and equally valid. But, my interpretation here is that they expect candidates to understand that actual performance is better than estimated performance, and the use of model management fees is more of an estimate of performance results than the use of actual management fees. Thus, b) is the best answer, because it provides for a net-of-fees return that is the best representation of the actual net-of-fees return for the composite in question.

I welcome other interpretations on this, so please feel free to comment.