Net-of-fees returns

Net-of-fees returns show the actual investment performance that investors receive after all fees and expenses have been subtracted from gross returns. This calculation gives investors the most accurate picture of their real experience. The hedge fund industry uses this as the standard measure for reporting and comparing performance.

To understand this concept, consider the difference between gross and net returns. represent the fund's investment performance before any deductions. Net-of-fees returns show what investors actually receive after paying for fund management and operations. This distinction matters because fees compound over time and can significantly reduce overall returns.

The Securities and Exchange Commission (SEC) has created clear rules for how investment managers must present performance results. The SEC considers it misleading and prohibited to show performance results before deducting advisory, brokerage, and other fees. Such presentations fail to show the true cost of compensation paid to advisers and others, which reduces the actual returns that investors receive.

The regulator emphasizes that simply disclosing applicable fees when showing gross performance is not enough. Investors cannot easily calculate the cumulative negative impact that compounding fees have on performance results over time. Therefore, net-of-fees presentations protect investors by providing transparency about their true returns.

Net-of-fees returns account for all fund-level expenses that reduce what investors receive. These expenses include , or allocations, administration fees, audit fees, legal fees, and other operating expenses. This comprehensive approach to deductions ensures that performance figures reflect the actual economic benefit received by investors rather than theoretical returns that ignore the cost of investment management.

The range of deducted expenses is broad because hedge funds have complex operational requirements. Management fees typically range from 1-2% of assets annually, while performance fees often take 15-20% of profits above certain thresholds. Administrative costs, while smaller individually, can add up significantly over time when combined with other operational expenses.

Although net-of-fee returns remain the regulatory standard, the SEC does allow investment advisers to show in certain limited situations. Advisers may present gross performance only if they also show net-of-fees performance with equal prominence. They must also include proper disclosure that explains how the calculations were made and clarifies that gross performance does not reflect the payment of advisory and other fees and expenses.

Recent guidance from March 2025 addressed specific challenges advisers faced with two narrow areas: extracted performance (like individual investment case studies) and certain investment characteristics (such as sector returns or risk metrics like the Sharpe ratio). Under this limited guidance, advisers may present gross performance of individual investments or investment characteristics without showing corresponding net figures for those specific items, but only if four strict conditions are met.

1. The extracted performance or characteristic must be clearly identified as gross performance
2. It must be accompanied by the complete portfolio's gross and net performance calculated according to Marketing Rule requirements
3. The complete portfolio performance must be presented with equal prominence and designed to facilitate comparison
4. The complete portfolio performance must cover a period that includes the entire timeframe of the extracted performance or characteristic

This guidance provides narrow relief for specific presentation challenges but does not broadly expand when gross performance can be shown - the general requirement to present net-of-fee performance alongside gross performance remains the regulatory standard.

When different clients pay different advisory and other fees, the SEC does not require advisers to present performance that reflects the actual fees charged to each specific client. Instead, the SEC allows advisers to present performance results calculated using the highest fees charged to any client. This approach must include appropriate disclosures that explain how such performance results were calculated.

This practice ensures that performance presentations are conservative and do not overstate returns for any investor group. Investors can understand that their actual returns may be higher if they pay lower fees than the maximum fee structure used in the calculations.

The regulatory framework surrounding performance advertising stems primarily from the 1986 , which identifies several practices considered false or misleading when presenting performance results. Among these prohibited practices is the failure to adjust performance results for advisory fees, brokerage commissions, or other expenses.

This guidance reinforces the importance of net-of-fee presentations for maintaining regulatory compliance. However, advisers should note that current requirements have evolved beyond the original Clover Capital framework and now include additional considerations for performance presentation and advertising practices.

Investment advisers must maintain comprehensive records that support their performance presentations. Current recordkeeping rules require to preserve information and documents used to form the basis for performance results, including net-of-fee calculations. These records must be kept for five years from the end of the fiscal year in which the advertisement with performance results was last published or communicated.

These records must be maintained in an easily accessible format. The first two years must be kept in an appropriate office of the adviser for immediate access during or regulatory inquiries. This requirement ensures that advisers can demonstrate the accuracy and methodology behind their performance calculations when regulators conduct reviews.