What is high water mark?

Definition and Examples of High Water Mark

A high water mark is the highest net asset value that an investment fund or your own account has reached. The high water mark is an important milestone for alternative investment fund investors because the fees you pay are often partially determined by the increase in the value of your account above the previous high water mark.

How Does the High Water Mark Work?

The high water mark for an alternative investment fund is set each time the fund’s value exceeds the previous highest value. The high water mark does not decrease; it only increases. When the fund generates returns exceeding the high water mark, the fund can charge you fees on the value of returns that exceed the mark. If the fund does not generate returns above the mark, you will not pay performance fees.

High Water Mark vs. Hurdle Rate

In addition to the high water mark, alternative investment funds may have a hurdle rate. The hurdle rate is the minimum return that the fund must achieve before performance fees are applied. This is often in addition to the high water mark.

What Does This Mean for Individual Investors?

If you decide to invest in an alternative investment fund, the high water mark condition can prevent you from paying performance fees on returns that merely offset previous losses. In a fund without a high water mark, you would lose money in addition to losses due to a decrease in value.

For example, suppose you invested one million dollars in a fund, and over the year, the investments grew by 15%. You would have earned $150,000 in profit, and your account value would be $1.15 million at the end of the year. If you had to pay a performance fee of 20% on the profits, the fee would be $30,000, or 20% of the $150,000 profit.

Second, suppose the investment lost 15% after your account had grown to $1.8 million after several years. Due to the loss, there are no profits; thus, there are no performance fees. You would have $1.53 million in your account.

The high water mark remains stable and does not decrease, serving as an incentive for fund managers to achieve new high water marks.

Source: https://www.thebalancemoney.com/what-is-a-high-water-mark-5205643