In today’s marketplace, investment management fees vary widely from one product to another, as well as from one client to another. Fee calculations range from simple to quite complex.
In their most basic form, management fees are a flat percentage of assets under management. However, investment advisors and clients can often better meet their objectives using more advanced fee structures. To reward clients who entrust them with larger asset amounts, investment advisors often use tiered rate schedules that offer lower fee percentages as the amount of assets under management increase.
Tiered rate schedules are just the tip of the iceberg, as there are many other factors which may impact fee calculations:
- Performance fees
- Investment allocations
- Waterfall calculations
- Differing schedules for different clients
- Aggregation of multiple related accounts for use in a unified tier schedule
- Rebates for investment in multiple firm funds (some of which may be invested in other firm funds)
- Most favored nation clauses (where an investment advisor is required to make sure that the client with the clause always gets the lowest fee charged to any of the investment advisor’s clients)
- Alternate calculations when client contribution and withdrawals occur
Unfortunately, most mainstream accounting and billing systems are unable to cope with the variety and complexity of an investment manager’s varied fee calculations. Many investment managers utilize spreadsheets, internally developed databases, or one of a few specially designed (and costly) software packages in the marketplace.
Here are some common calculation errors:
- Using an outdated fee schedule
- Using the incorrect tier
- Not calculating performance fees in addition to base fees
- Missing or misapplying hurdle, claw back, and high water mark provisions
- Using the incorrect period for performance calculations
- Not aggregating all accounts for grouped tier calculations
- Not handling client inflows and outflows according to contractual terms
It can be embarrassing for a manager if a client discovers they were charged too much. On the other side of the coin, investment advisors generally do not like to undercharge, leaving money on the table.
In addition to carefully considering which systems to utilize, managers should perform procedures to test the accuracy of revenue calculations on a periodic basis. Investment advisors can do this internally or hire a firm to assist in the process.
One approach is to sample the fees. For the sample accounts selected, the recalculation process generally involves:
- Obtaining the most current fee schedule
- Obtaining custodial records to support market values
- Carefully reading the fee calculation terms as well as any related contractual provisions that might impact fee calculations
- Recalculating the fee
For many types of asset classes and clients, this is a relatively straightforward process. For alternative investment funds, allocation and waterfall calculations generally need to be calculated from the inception of each fund.
If a manager were to make recalculations once or twice per year, the sample could be rotated so that over a period of time (such as 3 to 4 years), the process would cover most of the accounts. We recommend starting with the most complex accounts that have the greatest probability of errors.
If errors are found, investment advisors should implement processes and controls to minimize future miscalculations. Investment advisors can also inform their clients that their own systems of controls caught the error, a far better alternative to a client discovering an error that has completely escaped detection by the investment advisor.
The fee calculation process is varied and complex. Take the time and effort to do it right. It is essential to ensuring you are not leaving money on the table…or upsetting clients unnecessarily.
We will be happy to provide further information relating to this subject. For more information, contact Thomas A. Peters, Director, Audit & Accounting and member of Kreischer Miller’s Investment Industry Group at firstname.lastname@example.org or 215.441.4600.