Many firms provide their clients or prospective clients with net-of-fee returns. I happen not to generally like these in a GIPS(R) (Global Investment Performance Standards) presentation, as their value is questionable. If you use actual fees, these fees typically vary, so the result has little meaning to the recipient…it’s the result of a hodgepodge of fees being removed and usually bears no resemblance to what the prospect would have paid. If you use highest fee, this will often make you look worse, even though the prospect may not be expected to pay this amount. Reporting to a client is different: they should see net-of-fee performance as this is truly applicable to them.

Let’s say you want to calculate net-of-fee for a GIPS presentation: should you accrue your quarterly fees monthly? If you only report annual returns, is it okay to deduct the annual fee from the annual gross? Or, should you deduct fees as they would be charged (e.g., quarterly)?

I ran a quick test (with an annual fee of 1%) to see what might happen and discovered some interesting results.

I was surprised that the quarterly actual versus the monthly accrual would be essentially the same, as I expected the more frequent compounding would make it significantly lower; apparently the less frequent (quarterly) compounding of the higher fee balances out the more frequent compounding. This also begs the question, “why accrue?”

What I think is perhaps most important is that by only removing the fee annually, the net-of-fee return avoids the compounding. And while this is a handy and convenient way to accomplish deriving the net-of-fee return, it clearly overstates it, because of the absence of compounding.

In my opinion, if you charge your fees quarterly they should be deducted quarterly.

I will present additional examples in our newsletter which will show similar results.