Understanding Performance Fees and High-Water Marks

Strategists are usually paid a share of the profit they produce for copiers. The share is the performance fee, and the rule that decides which profit it applies to is the high-water mark. Both are simple once seen in an example, and both matter more than their size suggests.

The performance fee

A performance fee is a percentage of net new profit on the copy account over a settlement period. If the copy gains, the strategist receives the stated share of the gain. If the copy loses, no fee is due.

The high-water mark

The high-water mark is the highest value the copy account has reached at the end of any previous settlement period. A fee is charged only on profit above that mark. Suppose the account rises in the first period and a fee is paid. In the second period it falls. In the third it rises back to the old peak. No fee is due in the third period, because the profit only recovered a loss that had already been counted. A fee is next due only when the account passes the old peak.

Without a high-water mark, a copier would pay fees on the same profit twice: once when it was first earned and again when it was earned back after a loss. The mark prevents that.

Worked through in words

Account starts at one hundred. Rises to one hundred and ten: fee on ten. Falls to ninety-five: no fee. Rises to one hundred and five: no fee, still below the mark of one hundred and ten. Rises to one hundred and twenty: fee on ten, the part above the mark. The mark moves to one hundred and twenty. It never moves down.

Questions to ask

• Is there a high-water mark, and does it reset?
• What is the settlement period, and what happens if you stop copying partway through?
• Are broker costs such as spreads and swaps deducted before the fee is calculated?
• Can the rate be changed, and with what notice?
• Where are the fee calculations shown before they are settled?

A fee structure that answers all of these clearly is fair even if the rate is high. One that is vague on the mark or the reset is expensive even if the rate is low.

What to watch

Watch the fee shown on your statement against your own calculation from the mark, the settlement dates, and any notice of a rate change. A fee that appears after a losing period is a fee to question.