What does a high-water mark actually do in a hedge fund fee calculation?
I understand that hedge funds can charge performance fees, but the high-water mark keeps confusing me. Is it a return target, a prior NAV, or something else?
A high-water mark is the prior peak value on which performance fees have already been earned. It protects investors from paying a performance fee twice on the same recovery.
If a fund previously reached USD 105 million after fees, then fell to USD 90 million, the manager generally does not earn a new performance fee just because the fund rises to USD 100 million. The fund is still below the previous high-water mark. A performance fee becomes possible only after the relevant fee basis exceeds the high-water mark, subject to any hurdle-rate language in the problem.
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