Insights for GIPS Compliant Asset Owners – Getting comfortable with CFA Institute’s Net-of-Fee Terminology

During 2021, pension plan headlines included fee transparency, the improper treatment of cash flows (and its impact on performance), and the pros and cons of claiming compliance with the GIPS Standards for Asset Owners, to name a few. The number of public and private pension funds, endowments and foundations claiming compliance with the GIPS Standards is growing.  This article addresses key pros and cons and details net of fee reporting terminology for funds considering compliance with the GIPS Standards to consider.

The Pros:

Compliance with the GIPS Standards is largely an exercise in shoring up books and records, augmenting documentation of internal workflows, and gaining clarity on outsourced performance practices of third-party managers and consultants—all important exercises for fiduciaries.  It demonstrates a commitment to best practices, full and fair disclosure, and robust internal documentation that can lead to operational efficiency and enhanced internal controls.  It can also expose documentation gaps that can be corrected, if not historically, on a go-forward basis, with the ability to comply with the GIPS Standards once compliance can be supported for a 12-month performance history in the GIPS Total Fund Report, which contains pertinent disclosures that are comparable among funds globally.

The Cons:

As fiduciaries, funds must manage costs.  For asset owners already subject to GASB audits, complying with the GIPS Standards for Asset Owners will only build on required valuation and calculation methodologies already in place.  The GIPS Total Fund Report can be seen as an extra layer of voluntary reporting.

Having worked with audited firms and funds for over 25 years, Cascade has seen first-hand that more than an extra layer, the process of getting into GIPS compliance connects an organization’s people to the performance results in a way that undergoing an audit does not.   A fund audit is focused on the data, while the GIPS Standards focuses on the organization.  Interviews with compliant funds continue to find the focus on policy documentation the most helpful part of the GIPS compliant process.  Improved recordkeeping and collaboration inside of and between departments reinforces ongoing operational improvements.

Total Fund Net-of-Fee Terminology

Below is a summary of the GIPS Standards net-of-fee terminology, what must be included in a total fund net-of-fee return, and the different types of additional returns that can be included in a GIPS Total Fund Report.

The GIPS Standards for Asset Owners (provision 22.A.24) require that a total fund net of fee return be calculated net of transaction costs, all fees and expenses for externally managed pooled funds, investment management fees for externally managed segregated accounts, and investment management costs.  Below is a breakdown of what is included in each of the above fees and what is not included.

1. Transaction Costs

CFA Institute limits transaction costs to the cost of buying and selling investments.

2. All fees and expenses for externally managed pooled funds and investment management fees for externally managed segregated accounts

If asset owners can use net asset values from externally managed pooled funds when they value them within the larger total fund, and the net asset value includes the management fee, then no additional work is required.  However, if there are other investment management fees being paid for the management of the external pooled fund from another account, such as a fund-of-fund management fee, these expenses must also be included.  Carried interest also falls under investment management fees and must be included.  Similarly, for segregated accounts, investment management fees must include any performance-based fees or manager of manager fees, in addition to asset-based fees.

3. Investment management costs

The GIPS Standards for Asset Owners define investment management costs as “all internal costs for both internally and externally managed assets.” This ensures the oversight board has a look through for all the fees associated with operating the pension fund, endowment, or foundation.  Capturing a fund’s internal investment costs, as well as external management fees and transaction costs, is not new to funds regularly undergoing GASB audits.  GIPS compliance does typically result in more robust documentation and disclosure of what is and isn’t included in a total fund’s annual net-of-fee performance, including additional clarity on the net-of-fee performance-related data from external managers.  Fees an Asset Owner will want to consider when determining internal investment management costs:

Asset Owners must present performance net of all fees; however, the total fund performance may also include different types of returns in addition to the total fund net-of-fee return.  In a GIPS Total Fund Report, four other types of returns can be presented, with additional disclosure:

Cascade Compliance has decades of experience working with the GIPS standards, and its employees have worked with firms and asset owners.  One of the best parts of working with clients is getting to share expertise and knowledge of best practices across the industry.  Whether you are a client of ours or not, we are here to help you get better at what you do and answer any questions you may have.