what is a high water mark 
a high water mark is the highest peak in value that an investment fund or account has reached this term is often used in the context of fund manager compensation which is performance based 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 aum 1investopedia julie bangunderstanding high water marka high water mark ensures that investors do not have to pay performance fees for poor performance but more importantly guarantees that investors do not pay performance based fees twice for the same amount of performance a high water mark is different from a hurdle rate which is the lowest amount of profit or returns a hedge fund has to earn to charge an incentive fee high water mark examplefor example assume an investor is invested in a hedge fund that charges a 20 performance fee which is quite typical in the industry 2 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 markthe 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 a high water mark both protects the fund s investors from double fees and motivates the fund s managers to perform well in order to earn fees a high water mark and the free ride several things can happen when an investor enters a fund during a period of under performance for instance at goldman sachs asset management an investor who buys into the fund at a net asset value nav below the high water mark will enjoy the upside from the subscription nav to the high water mark without paying a fee this situation is known as a free ride it allows new investors to benefit from buying into an under performing fund without penalizing existing investors other funds may avoid the free ride by charging a performance fee for any positive performance 