High-Water Mark

Loading the player...

What is a 'High-Water Mark'

A high-water mark is the highest peak in value that an investment fund or account has reached. This term is often used in the context of fund manager compensation, which is performance-based. The high-water mark ensures the manager does not get paid large sums for poor performance. If the manager loses money over a period, he must get the fund above the high-water mark before receiving a performance bonus from the assets under management (AUM).

BREAKING DOWN 'High-Water Mark'

High-water marks ensure that investors do not have to pay performance fees for poor performance, but more importantly, guarantee that investors do not pay performance-based fees twice for the same amount of performance.

High-Water Mark in Practice

For example, assume an investor is invested in a hedge fund that charges a 20% performance fee, which is quite typical in the industry. Assume the investor places $500,000 into the fund, and during its first month, the fund earns a 15% return. Thus, the investor's original investment is worth $575,000. The investor owes a 20% fee on this $75,000 gain, which equates to $15,000.

At this point, the high-water mark for this particular investor is $575,000, and the investor is obligated to pay $15,000 to the portfolio manager.

Next, assume the fund loses 20% in the next month. The investor's account drops to a value of $460,000. This is where the importance of the high-water mark is noted. A performance fee does not have to be paid on any gains from $460,000 to $575,000, only after the high-water mark amount. Assume in the third month, the fund unexpectedly earns a profit of 50%. In this unlikely case, the value of the investor's account rises 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 equates to 20% on a gain of $230,000, or an additional $46,000 in performance fees.

The high-water mark prevents this "double fee" from occurring. With a high-water mark in place, all gains from $460,000 to $575,000 are disregarded. But gains above the high-water mark are subject to the performance-based fee. In this example, beyond the original $15,000 performance-based fee, this investor owes 20% on the gains from $575,000 to $690,000, which is an additional $23,000.

In total, with a high-water mark in place, the investor owes $38,000 in performance fees, which is $690,000 less the original investment of $500,000 multiplied 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 equates to $61,000. The value of a high-water mark is unquestionable.

RELATED TERMS
  1. Performance Fee

    A payment made to a fund manager for generating positive returns. ...
  2. Exchange Fees

    A type of investment fee that some mutual funds charge to shareholders ...
  3. Management Fee

    A charge levied by an investment manager for managing an investment ...
  4. Cumulative Discount Privilege

    A way that an investor in a mutual fund can qualify for lowered ...
  5. Fulcrum Fee

    An additional, performance-based fee an advisor charges a client. ...
  6. Performance-Based Index

    A stock index that includes all dividends and other cash events ...
Related Articles
  1. Managing Wealth

    Explaining the High-Water Mark

    A high-water mark ensures fund managers are not paid performance fees when they perform poorly.
  2. ETFs & Mutual Funds

    A Guide To Investor Fees

    Fees are one of the most important determinants of investment performance and something that every investor should know.
  3. Financial Advisor

    How To Optimize Your Portfolio and Reduce Fees

    Investment fees aren't avoidable altogether, but there are strategies investors can employ to keep those fees at bay and reduce the impact on returns.
  4. Retirement

    Are Fees Eating Up Your Nest Egg?

    You may not be able to avoid all fees associated with retirement planning, but you should know what you’re being charged for. Here's a list of common fees.
  5. ETFs & Mutual Funds

    Fund Of Funds - High Society For The Little Guy

    Like a mutual fund, FOFs provide instant diversity by grouping many hedge funds into one product.
  6. Retirement

    Are Fees Depleting Your Retirement Savings?  

    Each retirement account will have a fee associated with it. The key is to lower these fees as much as possible to maximize your return.
  7. Financial Advisor

    Are Financial Advisor Fees Too High?

    Fees charged by financial advisors run the gamut. Are you getting a fair deal or paying too much?
  8. Financial Advisor

    5 Signs Fund Fees Are Hammering Your Investments

    The worst long-term killer of investment gains isn’t the market; it’s fees, especially for retirement accounts. How do you know if you're paying too much?
  9. ETFs & Mutual Funds

    5 Characteristics of Strong Mutual Fund Shares

    Discover some of the basic characteristics shared by good mutual funds that investors can use to help them in selecting funds.
  10. Personal Finance

    3 Investment Fees You Can't Lower

    Investment fees are a guarantee for every investor. Knowing what's negotiable and what isn't when it comes to these charges puts you in a better position.
RELATED FAQS
  1. What's the difference between the hurdle rate and the high water mark?

    Discover how hurdle rates and high water marks are used by hedge funds for calculating incentive or performance fees charged ... Read Answer >>
  2. How do mutual fund expense ratios affect returns?

    Learn what kinds of mutual fund fees there are, how to find out what fees your funds have and how they impact the future ... Read Answer >>
  3. Why do mutual fund companies charge management fees?

    Learn why mutual funds charge their investors management fees, which include the cost of hiring investment advisors and various ... Read Answer >>
  4. What are typical trust fund management fees?

    Learn about trust fund management fees, such as the annual management fee, annual expense ratio, brokerage commissions and ... Read Answer >>
  5. Where do I look for fees that I am charged on investments? What are those fees called?

    The fees and expenses charged for investments vary. The fees usually depend on the type of investment and the investment ... Read Answer >>
  6. Is smart beta cheaper than hedge funds?

    Discover how to estimate and compare the added expenses for smart beta strategies and hedge funds to see if they are the ... Read Answer >>
Hot Definitions
  1. Brazil, Russia, India And China - BRIC

    An acronym for the economies of Brazil, Russia, India and China combined. It has been speculated that by 2050 these four ...
  2. Brexit

    The Brexit, an abbreviation of "British exit" that mirrors the term Grexit, refers to the possibility of Britain's withdrawal ...
  3. Underweight

    1. A situation where a portfolio does not hold a sufficient amount of a particular security when compared to the security's ...
  4. Russell 3000 Index

    A market capitalization weighted equity index maintained by the Russell Investment Group that seeks to be a benchmark of ...
  5. Enterprise Value (EV)

    A measure of a company's value, often used as an alternative to straightforward market capitalization. Enterprise value is ...
  6. Security

    A financial instrument that represents an ownership position in a publicly-traded corporation (stock), a creditor relationship ...
Trading Center