Hey, everyone! I’m excited to explain how high-water marks work in Hedge Funds!
Hedge funds typically charge two types of fees…
- Management fees (2%)
- Performance fees (80% to the investor, 20% to the manager)
This is the 2/20 model.
Crunching Some Numbers
Using the 2/20 model above, let’s say our fund starts out with $50k.
Let’s say the fund did super well in term 2, dropped in term 3, then rose in term 4. Here are the numbers:
- Term 1 = $50k
- 2 = $150k
- 3 = $100k
- 4 = $200k
From Term 1 to term 2, the investor pays 80% and the manager pays 20%. There are no fees from Term 2 to Term 3 because no money was made.
The high-water mark suggests that no fees will be charged on capital that was already made but recently lost.
So, the first $50k that was made from Term 3 to Term 4 will not have any fees attached because it was already paid for.
This way, fund managers don’t collect the same fees 2 or 3 times just because the fund value is fluctuating.
The high-water marks in hedge funds ensure that the fund manager splits the fees as promised, without double charging.
I get asked, “How long does this go on for? Does it ever reset?” Like I said in my video…
“You’re the fund manager, you decide. However, typically you don’t reset your high-water mark, it stays for the length of the hedge fund. It’s there to protect your investors from being double-charged.”
See you soon,
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DISCLAIMER: This content is for educational and informational purposes only. It is not to be taken as tax, financial, or legal advice. You should always consult a legal professional before taking action. Furthermore, this is not a recommendation to buy or sell any security. The content is solely just the opinion of the authors.