High-Water Mark

What Is a High-Water Mark?

A high-water mark is the highest top in value that a investment fund or account has reached. This term is in many cases utilized with regards to fund manager compensation, which is performance-based. The high-water mark guarantees the manager doesn't get compensated large aggregates for poor performance. In the event that the manager loses money over a period, he must get the fund over the high-water mark before getting a performance bonus from the assets under management (AUM).

Seeing High-Water Mark

A high-water mark guarantees that investors don't need to pay performance fees for poor performance, however, more significantly, guarantees that investors don't pay performance-based fees two times for a similar amount of performance.

A high-water mark is unique in relation to a hurdle rate, which is the most minimal amount of profit or returns a hedge fund needs to earn to charge an incentive fee.

High-Water Mark Example

For instance, expect an investor is invested in a hedge fund that charges a 20% performance fee, which is very commonplace in the industry. Expect the investor places $500,000 into the fund, and, during its most memorable month, the fund earns a 15% return. In this way, the investor's original investment is worth $575,000. The investor owes a 20% fee on this $75,000 gain, which compares to $15,000.

As of now, the high-water mark for this specific investor is $575,000, and the investor is committed to pay $15,000 to the portfolio manager.

Next, accept the fund loses 20% in the next month. The investor's account drops to a value of $460,000. This is where the significance of the high-water mark is noted. A performance fee doesn't need to be paid on any gains from $460,000 to $575,000, solely after the high-water mark amount. Expect that in the third month the fund startlingly earns a profit of half. In this improbable case, the value of the investor's account ascends from $460,000 to $690,000. Without a high-water mark in place, the investor owes the original $15,000 fee, plus 20% on the gain from $460,000 to $690,000, which compares to 20% on a gain of $230,000, or an extra $46,000 in performance fees.

Value of a High-Water Mark

The high-water mark forestalls this "double fee" from happening. With a high-water mark in place, all gains from $460,000 to $575,000 are dismissed, yet gains over the high-water mark are subject to the performance-based fee. In this model, past the original $15,000 performance-based fee, this investor owes 20% on the gains from $575,000 to $690,000, which is an extra $23,000.

Altogether, with a high-water mark in place, the investor owes $38,000 in performance fees, which is $690,000 not exactly the original investment of $500,000 duplicated by 20%. Without a high-water mark in place, which is below industry standards, the investor owes a 20% performance fee on all gains, which likens to $61,000. The value of a high-water mark is certain.

A high-water mark both safeguards the fund's investors from double fees and propels the fund's managers to perform well, to earn fees.

A High-Water Mark and the "Complementary lift"

A few things can happen when an investor enters a fund during a period of under-performance. For example, at Goldman Sachs Asset Management, an investor who gets involved with the fund at a net asset value (NAV) below the high-water mark will partake in the upside from the subscription NAV to the high-water mark without paying a fee. This situation is known as a "complementary lift." It permits new investors to benefit from buying into a failing to meet expectations fund without punishing existing investors. Different funds might stay away from the "complementary lift" by charging a performance fee for any positive performance.

Highlights

• The purpose is to shield investors from paying a fee for poor performance, and from paying a fee more than once every time the fund earns a profit.
• A high-water mark is the highest level in value an investment account or fund has reached.
• A high-water mark is much of the time utilized as an outline point in determining performance fees that an investor must pay.
• With a high-water mark, the investor pays a fee that main covers the amount the fund earned between the point of entry and its highest level.