High-water Mark Principle
A high-water mark is the highest value that a fund has reached. The high-water mark principle is to ensure that the manager does not get paid performance fee for recent poor performance. If the manager loses money or makes less money over a period, he must take the fund value above the previous high – that is the high-water mark -- before receiving a performance fee.
Here is how it works. The calculations here are as per SEBI's regulations on HWM.
Let us assume that an investor has invested Rs1 crore in one of our schemes and this is how the performance has been for the first four years
In the first year, the fund earns Rs 19,00,000 (19%) and as our performance is above the hurdle rate of 10% we would be entitled to get performance fees. Now the high-water mark to beat for the following year is Rs 1.18 crore. The next year, the fund earns a 11% gross return. Although the gross return is above the hurdle rate, considering the Fixed fees, other expenses and the hurdle level, the value arrived is not above the high water mark so we are not entitled for any performance fees. A new high-water market is set at Rs 1.28 crore. For the same reason despite positive performance in third year, we are not entitled to performance fees. A new high-water mark is set at Rs 1.40 crore.
Fourth year being the year of negative return, there is no performance fees. The high-water mark is continues to be at Rs 1.40 crore.
Fifth year with a 55% gross return, the amount arrived after considering fees and hurdle level is above the previous high-water mark of Rs 1.40 crore, hence that entitles us to claim for the performance fees. And accordingly the new high-water mark is set at Rs 1.54 crore.
Fees and HWM principle are calculated and applied for each investor depending on his or her entry into the PMS.
The hurdle rate ensures that investors do not have to pay performance fees for poor performance, while the HWM guarantees that investors do not pay performance-based fees twice for the same performance.