High-Water Mark
The highest peak value a fund has reached, above which a manager must perform before earning performance fees again.
What is High-Water Mark?
The high-water mark (HWM) is the highest net asset value (NAV) that a hedge fund, private equity fund, or other investment vehicle has previously achieved. It is a contractual protection for investors: fund managers can only charge performance fees (typically 20% of profits) on gains above the HWM. If a fund loses value, the manager must recover all prior losses — returning the NAV to the previous high-water mark — before earning any new performance fees. This aligns manager incentives with investor interests by preventing 'fee double-dipping' when a manager earns fees on gains that merely recover previous losses. High-water marks are the standard in the hedge fund industry and are typically combined with a hurdle rate, which requires the fund to clear a minimum annual return (e.g., LIBOR + 2%) before performance fees apply.
Example
A hedge fund starts at $100M NAV. In year 1, it earns 20% → NAV rises to $120M. The manager charges a 20% performance fee on the $20M gain = $4M fee. In year 2, the fund loses 15% → NAV falls to $102M. The high-water mark is still $120M. In year 3, the fund gains 30% → NAV rises to $132.6M. The manager only earns a performance fee on the $12.6M above the $120M HWM, not on the full $30.6M gain.