Things to know about incorporating mutual funds into a GIPS composite

Many asset managers who are seeking compliance with the Global Investment Performance Standards (GIPS®) want to include mutual funds. While this is fairly easy to do, there are a few things that you should think about.

Include in separate composites or with separate accounts?

If you are going to include mutual funds in your firm definition, you’ll want to give some thought to whether they will reside in their own composites or be included in composites along with separate accounts.

Some quick pros and cons of each:

Include with separate accounts

The biggest advantage with incorporating mutual funds into a GIPS composite is the composite’s assets will be larger.

In many cases, the composite’s history will be longer, too.

One disadvantage of combining them is that your composite have more dispersion, since funds typically experience daily flows (and therefore may experience more trading), while separate accounts do not.

Separate composites

If you elect to keep them separate, you will probably see lower dispersion. Other than that, I don’t see a lot of reasons to keep them separate, and most of our clients combine them.

What about the fund’s returns?

Mutual fund returns are typically NAV (net asset value) based. At least in the United States, mutual funds won’t typically come with gross-of-fee (GOF) returns, but will be net-of-fee (NOF) only. In addition, these NOF returns will be net of not only transaction costs and management fees, but other charges, which GIPS generally doesn’t care about, and doesn’t require your net-of-fee calculation to exclude (i.e., your NOF returns can be gross of these other charges).

A question we often get is how to handle multiple share classes.

Here is the solution we generally recommend:

1. First, gross up your net-of-fee return (i.e., strip all the fees out, save for trading costs).
2. Now, net the return down by a “model” fee, such as the highest maximum fee.

Since you will not be, at least in most cases, using your composite presentation to market your mutual fund, we think it makes the most sense to have a single NOF return, rather than blending the various returns from the different share classes. In addition, by first grossing the returns up, you are getting rid of those other fees that GIPS doesn’t care about.

We recommend showing the gross-of-fee returns along side the net-of-fee return.

What about the SEC?

For those firms that are registered with the U.S. Securities & Exchange Commission (SEC), you’ll want to be aware of a couple key points:

1. Yes, the SEC does allow you to gross up your net-of-fee fund returns. However, you cannot make reference to the actual fund(s) within the composite presentation. This is to keep you from trying to sell the fund via the GIPS documents.
2. If you decide to show only gross-of-fee returns, these presentations are only valid for one-on-one presentations. When marketing or presenting to more than one party at a time, you must show net-of-fee returns with equal or greater prominence to the gross-of-fee returns.

Placing your mutual funds into a GIPS composite should be one of the simplest aspects of compliance. Have any questions regarding other aspects or issues related to incorporating mutual funds into a GIPS composite? Please let us know, and we’ll try to respond.

Note: to see the actual SEC “no action letter” that speaks to these points, please go here.