The high water mark in investment is a term used primarily in the context of hedge funds, although it can also be relevant to some conventional funds. It refers to the highest peak in value that an investment fund or account has reached. This benchmark is crucial for calculating performance fees. The purpose of the high water mark is to ensure that fund managers are only rewarded for new profits, not for recovering past losses.
Under a high water mark scheme, performance fees are charged only on the profits that exceed the previous highest value. For example, if a fund reaches a new peak in its value, the manager earns a performance fee on the gains above the high water mark. If the fund then loses value and subsequently recovers, the manager does not earn a fee on the recovered amount unless the fund’s value surpasses the previous high water mark.
The high water mark is a favourable feature for investors as it aligns the interests of the fund manager with those of the investors. It ensures that managers are incentivised to generate consistent, long-term gains rather than taking excessive risks for short-term profits. However, investors should also consider other fee structures and terms of the fund to fully understand the cost and potential returns of their investment.
This Trustnet Learn article was written with assistance from artificial intelligence (AI). For more information, please visit our AI Statement.