High-Water Mark
Candlefocus EditorThe High-Water Mark (HWM) technique is commonly used by professional fund managers to ensure that the investors only pay for profitable management rather than for “non-working” periods. To calculate a high-water mark, you take the highest net asset value (NAV) performance of a particular fund and subtract the NAV when the fee structure was entered into the contract.
The concept of high-water mark was designed to protect investors from the “ship-jumping” or “chasing” manager. This is when an investor moves his or her capital away from a losing portfolio or fund and puts it into one that is doing better, only to pay an incentivization fee yet again. To prevent this, the high-water mark is used to make sure the investor only pays for performance results if it is above the high-water mark. If the portfolio or fund falls below the HWM, the performance fee does not apply.
In some cases, the high-water mark is adjusted for the effects of inflation or to include the effects of portfolio adjustments. This ensures that changes in the value of a portfolio caused by external influences, such as inflation and market movements, are not factored into the performance fee, thereby protecting the investor from excessive fees.
The high-water mark concept is used in many different investments, from hedge fund management to private equity funds to venture capital funds. It is an effective way to ensure that performance fees are tied directly to investment performance, and not to any external influences. With this structure, investors can trust that the fees they are paying are only in return for successful investments.