Net-of-fee returns: what to do with the denominator

A colleague recently brought to my attention wording that appears in the 1993 edition of the Performance Presentation Standards, published by AIMR (Association for Investment Management and Research; the former name of the CFA Institute). On page 25, under a section titled "Net-of-Fee Calculation" we find: "In a net-of-fee calculation, when fees are paid from the corpus of the fund, the payments should be included as a withdrawal of capital in F (flows) and in FW (weighted flows). In addition, performance results are reduced by deducting fees as negative income [a positive number] in the numerator." The accompanying formula (that appears on 26) has the fees removed, separate from their treatment as a flow.

What this essentially means is that the fees cancel out in the numerator (which is the same as my recommendation to ignore them). The AIMR-PPS's denominator has them as a weighted flow; I recommend not doing this. Their result is a higher NOF return (since the denominator is reduced by the weighted flow). I believe ignoring the fees entirely is correct.

As I pointed out in an article for the CFA Institute, as well as in our firm's newsletter and this blog, we should completely ignore net-of-fee payments that come from the corpus of the account; we treat them as flows for gross-of-fee returns.

Note: this is MY (i.e., Dave Spaulding's) view on this matter, but I believe that logic and the results show that it makes sense. But chime in with your thoughts, by inserting a comment below! In reality, whether you treat them as a weighted flow or not, the difference is probably de minimis.