The high watermark denotes the highest value achieved by an investment account or fund. It serves as a benchmark, marking the peak level attained in assessing performance fees for investors.
In essence, when an investment surpasses its previous highest value and establishes a new peak, performance fees are calculated from the profits generated beyond this high-water mark. However, if the investment declines below the high watermark, the manager typically doesn’t charge additional performance fees until the investment surpasses the previous peak, ensuring that investors are not charged for losses that have not been recovered. This mechanism aligns the interests of investors and managers, encouraging the latter to focus on generating profits to surpass previous highs before charging performance fees again.