What Is a High-Water Mark?

A high-water mark is the highest peak in value that an account has reached. 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.

High-Water Mark Example

For example, 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 that 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.

Value of a High-Water Mark

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 than 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.