## **Learning Outcomes**

This article explains GIPS performance calculation methodologies and fee treatments, including:

- Identifying when to present gross-of-fees versus net-of-fees returns under the GIPS Standards
- Applying correct deduction rules for management, performance-based, and transaction fees while excluding non-investment expenses
- Distinguishing between direct, indirect, bundled, and third-party fees, and allocating bundled charges in a GIPS-compliant way
- Calculating compliant returns using time-weighted and, where permitted, money-weighted methodologies, with appropriate treatment of external cash flows and accruals
- Evaluating how model, highest, and actual fee schedules affect reported composite performance and required disclosures
- Assessing the impact of custody, tax, and operating expenses on reported returns, and recognizing which items must not be deducted except when required by law
- Detecting common fee-related calculation errors frequently tested in the CFA Level 2 exam and interpreting worked numerical examples that illustrate correct methodology
- Comparing GIPS requirements with typical industry practices to better understand exam trick questions, disclosure nuances, and ethical implications of fee presentation choices

## **CFA Level 2 Syllabus**

For the CFA Level 2 exam, you are expected to understand how the GIPS Standards prescribe performance calculation methodologies and handling of fees, with a focus on the following syllabus points:

- Calculate performance in compliance with GIPS, including both gross-of-fees and net-of-fees returns
- Distinguish between fees, expenses, and the treatment of each when preparing GIPS-compliant returns
- Identify permissible and impermissible calculation methods, including the impact of accruals, cash flows, and firm-specific policies
- Apply correct approaches to model, bundled, and transaction-based fee scenarios under GIPS

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. Which fees must be deducted when calculating GIPS-compliant net-of-fees returns?
2. True or false? Performance must always be shown net of custody fees to comply with GIPS.
3. What is the treatment of performance-based fees in GIPS calculations?
4. Explain when the use of gross-of-fees and net-of-fees returns is permitted under GIPS.

## **Introduction**

Presenting investment performance fairly is central to the GIPS Standards. Correct calculation methods and consistent fee treatment are critical for both investor comparability and CFA exam accuracy. This article details the GIPS requirements and recommended practices for reporting returns, including the precise inclusion or exclusion of various fees and expenses, and covers the unique GIPS rules for special cases such as bundled fees or performance-based charges.

> **Key Term: Gross-of-fees return**
> The return on a portfolio or composite before the deduction of management fees but after transaction costs; excludes all fees payable to the investment manager, but transaction expenses must always be deducted.
>
> **Key Term: Net-of-fees return**
> The return after deducting investment management fees (and any other fees as required by GIPS) but before withholding taxes; always net of both transaction costs and management fees.
>
> **Key Term: Bundled fee**
> A single fee charged for multiple services (e.g., investment management, administrative, custody), making the allocation of expenses within the bundle necessary for proper GIPS-compliant reporting.

## GIPS PERFORMANCE CALCULATION METHODOLOGIES

### Gross-of-Fees Returns

Gross-of-fees performance must exclude all fees and expenses charged for investment management but includes the deduction of transaction costs. Indirect costs (such as custody, legal, or accounting fees) are not deducted. GIPS allows gross-of-fees reporting only if:

- Transaction costs are deducted
- Management fees are excluded
- Returns do not reflect non-investment-related expenses

### Net-of-Fees Returns

Net-of-fees performance deducts actual investment management fees and transaction costs (and, if applicable, performance-based fees where incurred). Indirect taxes, custody fees, and fund or partnership operating expenses are not deducted unless required by law. Net-of-fees returns must also be reduced by any incentive or performance fees the investment manager is entitled to according to the prospectus or client agreement.

### Required Fee and Expense Treatments

Under GIPS, managers must use actual fees incurred whenever possible. If using model or highest-fee scenarios, they must be disclosed. For composites that include portfolios with different fee schedules, the highest applicable fee should be used unless otherwise disclosed. When clients incur bundled fees, only the portion attributable to investment management and transaction costs must be allocated and deducted according to GIPS rules.

GIPS-compliant firms may not deduct:

- Fees paid to third parties (unless bundled)
- Taxes withheld on income or capital gains (unless required by law)

Custody fees, when not part of a bundled arrangement, must be excluded.

### Handling of Bundled Fees and Performance-based Fees

When bundled fees make fee segregation unclear, use reasonable allocation methods and fully disclose fee components and allocation assumptions. If performance fees are charged, deduct them as incurred, ensuring the resulting returns reflect what the client would actually realize.

## Calculation Method Rules

GIPS requires time-weighted return (TWR) methodologies for composites where the manager does not control external cash flows. For portfolios with significant client-driven external cash flows, GIPS allows for money-weighted return (MWR) if disclosed and appropriate. Performance calculations must reflect all known and accrued income, account for accruals, and be computed at least monthly, or on a more frequent basis if significant cash flows occur.

### Reporting Requirements

Firms may present both gross- and net-of-fees returns; however, net-of-fees reporting is generally mandatory for retail clients and must always be shown if net figures are typically presented to current or prospective clients. If only gross-of-fees returns are shown, this must be fully justified and disclosed.

### **Worked Example 1.1**

An asset manager calculates the composite gross return as 9.7%. Clients are charged a 0.85% management fee and 0.10% custody fee, plus transaction costs of 0.09%. What is the compliant net-of-fees return for GIPS reporting?

> **Answer:**
> GIPS net-of-fees requires deduction of the management fee and transaction costs, but not custody. Net-of-fees return = 9.7% - 0.85% - 0.09% = **8.76%**.

### **Worked Example 1.2**

A composite contains portfolios charged three different management fee rates—0.60%, 1.00%, and 1.25%. If modelling fees for net-of-fees reporting, what guidance must be followed?

> **Answer:**
> The highest annual management fee of 1.25% should be deducted from gross returns unless an alternative approach is fully disclosed.

### **Worked Example 1.3**

A fund includes a bundled fee of 2%, which covers management, custody, and trading. If the management portion is 1% and trading is estimated at 0.15%, how should gross- and net-of-fees returns be presented?

> **Answer:**
> Gross-of-fees performance: deduct only the 0.15% trading expense. Net-of-fees performance: deduct both the 1% investment management fee and the 0.15% trading cost. Custody (the remaining 0.85%) should not affect either return.

### **Exam Warning**

> Calculating net-of-fees returns by deducting custody or administrative expenses—except where required by law or bundled—is a common exam trap. Deduct only investment management fees and performance/incentive fees. Always include transaction costs in both gross and net returns.

### **Revision Tip**

> For the CFA exam, memorize which fees are mandatory deductions for gross and net-of-fees GIPS returns and which should never be deducted unless bundled or required by law.

## **Summary**

GIPS-compliant return calculations depend on rigorous fee and expense treatment, ensuring only investment management fees and transaction costs reduce returns as mandated. Correct methodology and transparency in handling fees—including for bundled and performance-based charges—is essential to producing fair, comparable, and reliable performance presentations.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- Distinguish between gross- and net-of-fees GIPS returns and correct deduction sequences
- Deduct management and performance-based fees for net-of-fees, and only transaction costs for gross-of-fees returns
- Exclude indirect third-party fees (e.g., custody, legal, administrative), unless bundled or required by law
- Allocate bundled fees based on reasonable assumptions, disclose methodology in presentations
- Use highest fee for composites with multiple schedules unless otherwise disclosed
- Correctly apply methods to both time-weighted and money-weighted returns per GIPS
- Fully disclose all fee and expense treatments in composite presentations

## **Key Terms and Concepts**

- Gross-of-fees return
- Net-of-fees return
- Bundled fee

GIPS standards advanced - Calculation methodologies and treatment of fees