Composites Insights Series
This series focuses on the key insights from our recent webinar, Composites Best Practices: Staying ahead of the composites compliance and regulatory curve.
Our panel featured composites and Global Investment Performance Standards (GIPS®) industry experts, plus esteemed panelists from Guardian Performance Solutions LLC and Madison Investment Services.
SEC Marketing Rule: Do you switch to model fees?
There’s a number of factors advisers should consider when deciding whether to apply model fees to their portfolios. These include the type of fees charged, the intended audience for the performance information, and the level of compliance risk the adviser is willing to accept.
Applying model fees to portfolios
The Marketing Rule generally permits the use of actual fees when calculating net-of-fees performance; however, this may not always be appropriate, in particular, if there’s non-fee-paying accounts in the composite. It’s suggested in most situations, if non-fee-paying portfolios are included within a composite, a model fee should be applied.
It’s common knowledge the GIPS® Standards allow firms to include non-fee-paying accounts in composites. Under the GIPS® Standards, firms have the option of presenting actual net-of-fee performance and simply disclosing the percentage of non-fee-paying accounts included in the composite, eliminating the need to apply a model fee.
However, the SEC expects a model fee to be applied in these cases where non-fee-paying accounts are included in the composite. Advisers, therefore, need to consider switching to model fees. As some advisers look to using model fees holistically moving forward, they need to be cautious. For example, if you have performance-based fee-paying accounts, then applying a model fee will likely be challenging.
Advisers must also monitor the model fee they’re applying on an ongoing basis, to ensure it continues to be representative of the fees currently offered today. This is imperative as the SEC wants to ensure the performance information presented is appropriate to the intended audience and reflects the fees they would be charged today.
Presenting different net returns to different types of prospects
Advisers may offer different fees to different types of prospects and potentially produce separate net-of-fee return series and multiple versions of the same presentation, using those different net-of-fee returns. While many firms discuss taking this route, few have done so due to version control challenges and risks.
Many advisers feel it’s more beneficial to have one set of materials they can provide to everyone. In calculating net-of-fee performance, advisers typically take a conservative approach by looking across their entire investor audience and applying the highest model fee applicable. This way, they can eliminate overstating performance for anyone they provide performance to.
Some firms have composites which include multiple product types (eg., separate accounts, various types of funds, all with different fee schedules) within the same composite. In this type of situation, an adviser may maintain multiple versions of the composite net-of-fee returns, applying a model fee applicable to separate accounts in one instance and a model fee applicable to the various funds in the other. Another example: rather than creating a GIPS Pooled Fund Report, advisers can produce a GIPS Composite Report which contains that fund. While fund fees will differ, the adviser could apply a fee schedule for that fund and to the composite as a whole. Though this method may be better to use for one-off instances, it may also be more difficult to manage on a recurring basis.
Next steps to navigating model fees
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