# High water mark with hurdle rate - How to calculate?

Hi guys,

First post here, glad to join the rank and file.

Would anyone be able to provide color on the following question?

ASSUMPTIONS:

1 - a hurdle rate of 5% compounded

2 - subject to a high water mark

3 - performance fee of 20% of outperformance

YEAR 1:

The fund starts with NAV of \$100.

At the end of year 1 the funds NAV is \$120, i.e. 20% return.

Therefore, performance fee is equal to 20% * \$15 = \$3.

NAV after performance is now \$117.

YEAR 2:

At the end of year 2 the funds NAV is equal to \$120, i.e. Returned 2.5%.

QUESTIONS:

1 - At the end of year 1, is the high water mark \$117 or \$120?

2 - Can any outperformance fee be charged at the end of year 2 given that the fund has beaten the hurdle rate (on a cumulative basis)? Or is the hurdle set at 1.05 * highwater mark?

3 - And, for bonus kudos, would anyone care to explain the logic behind this?

Herkshire

Welcome to AF!

1 - \$117 since the fee is being deducted from NAV. The manager is only managing \$117 in the second year so that should be the basis for the calculation. If it was paid outside of NAV, you would use \$120.

2 - There would not be a fee for year 2 since the new hurdle is \$122.85.

3 - The highwater mark is designed to prevent double dipping on fees. Since you did not mention a clawback I’m assuming the manager does not have to re-pay any fees for under-performance in year 2. For example, if the manager loses 50% in year 3 they have been paid a fee even through the performance is well below the hurdle.

Thanks for the info and the welcome Chad, most appreciated!

Is a claback provision relatively standard these days?