Part II

What it costs

A return before fees is what the manager produced. A return after fees is what the investor kept. The gap between them is often larger than people expect, and the rules behind it are where many reconciliation breaks start.

Fees: what the manager takes, and how

Every fund charges for running money, and those charges come straight out of the fund's value. That's why the same portfolio shows two returns: gross of fees (before charges) and net of fees (what investors actually earned).

The main types of charge

Management fee: An annual percentage of assets. Roughly 0.05% to 0.25% for index funds, 0.5% to 1.5% for active funds, and 1% to 2% for hedge funds. It's accrued every valuation day and paid monthly or quarterly.
Performance fee: A share of the gains above a target. Common in hedge funds and some active funds. Chapter 6 covers it in depth.
Operating costs: Administration, custody, depositary, audit, legal and registration fees. Together with the management fee these make up the ongoing charges figure (OCF) or total expense ratio (TER).
Transaction costs: Broker commissions, bid-ask spreads, stamp duty and market impact. They're not in the OCF. They're buried inside the return itself, because the fund bought slightly higher and sold slightly lower than the mid price.
Entry and exit charges: One-off charges on subscriptions or redemptions. They reduce what the investor gets but don't touch the fund's NAV, so they don't show up in published fund performance.

How a fee gets into the NAV

Fees aren't taken as a lump sum at year end. Every valuation day the fund administrator books an accrual: a liability that reduces the NAV. A 0.75% fee on a 200 million fund accrues about 4,110 a day (200,000,000 × 0.75% ÷ 365). The liability builds up and is paid out of fund cash at month end. Because it was already deducted in the NAV, the payment itself doesn't move the NAV again.

Daily accrual = NAV × annual fee rate365

R_net ≈ (1 + R_gross) × (1 − fee for the period) − 1 roughly R_gross − fee

In plain termsA 1.5% fee sounds tiny next to a 7% return. But it's charged every year on everything in the account, including last year's gains. Fees compound against you exactly the way returns compound for you.

The long-run cost of a fee

Invest 100,000. Pick a gross return and a fee, and watch the gap widen.

Gross return per year

Annual fee

Holding period

Before feesAfter feesLost to fees

Value before fees

Value after fees

Lost to fees

Fees plus the growth they would have earned

Share of the gain lost

Same portfolio, different share classes

One pool of assets, several share classes with different fees. Every class earns the same gross return; each one's net return differs by its fee.

Share class	Annual fee	Net return per year	Value after the period

For practitionersUnder GIPS, a gross-of-fees return is after transaction costs but before investment management fees; a net-of-fees return is after management fees and any performance fees. A return before transaction costs ("pure gross", common for wrap or bundled-fee accounts) must be clearly labelled. Composite net returns may use a model fee only if it produces returns equal to or lower than actual fees. In the US, the SEC Marketing Rule requires net performance wherever gross is shown, with at least equal prominence. Watch the fee mechanics when reconciling: accrual on prior-day vs current NAV, 365 vs 360 day counts, tiered schedules, fee waivers and expense caps, and share-class-level fees that make a fund-level return meaningless.

All numbers are illustrative. The models are simplified for teaching: annual coupons, Black-Scholes options, simplified fee mechanics and no intra-period trading. Real systems add transaction-based returns, daily valuation, tax and corporate action processing, and reconciliation to the official TWR.