Next, let`s assume the fund loses 20% next month. The investor`s account falls to a value of $460,000. Here, the importance of the high seas leash is emphasized. There is no need to pay a performance fee for winnings from $460,000 to $575,000, right after the maximum amount. Suppose the fund unexpectedly makes a 50% profit in the third month. In this unlikely case, the value of the investor`s account will increase from $460,000 to $690,000. Without a high water point, the investor owes the initial fee of $15,000 plus 20% of the profit from $460,000 to $690,000, or 20% on a profit of $230,000 or an additional $46,000 in performance fees. The best way to fully understand how the water terminal clause works is to take an example. At the bottom of this page, we provide an Excel spreadsheet that performs the necessary calculations. Overall, at a high level, the investor owes $38,000 in return commissions, which is $690,000 less than the initial investment of $500,000 multiplied by 20%. Without a high threshold below industry standards, the investor owes a 20% performance fee on all profits, which equates to $61,000. The value of a deep-sea leash is undisputed.

Suppose a mutual fund charges an annual management fee of 2% and a return fee of 20%, which are typical industry rates. An investor invested $100,000 in the fund, which generated a return of 10% in Year 1, -3% in Year 2 and a return of 20% in Year 3. If the account increases by 20% next year, you will have an account value of $2.02 million. They would be liable for the 20% performance fee on profits made above the $1.8 million mark. In this case, it would be $2.02 million – $1.8 million = $220,000 x 20% = $44,000. A two-and-twenty agreement is a common fee structure for hedge funds, private equity funds and venture capital funds, where the fund charges investors 2% of assets under management (AUM) per year plus 20% of profits on an obstacle rate. As a rule, this obstacle rate is about 7% to 10%. If the limit rate is not exceeded in a given year, the “twenty” part of the fee would not apply. The barrier rate refers to a minimum level of return that a fund manager must achieve in order to receive a performance bonus. Now, the high threshold clause implies that the hedge fund manager can charge a performance fee after three months. The manager`s compensation is 20% of the increase in the value of the shares, or suppose, for example, that an investor is invested in a hedge fund that charges a 20% performance fee, which is quite typical in the industry. Suppose the investor invests $500,000 in the fund and in the first month the fund earns 15%.

Thus, the investor`s initial investment is worth $575,000. The investor owes a 20% fee on this profit of $75,000, or $15,000. Consider a hypothetical hedge fund called PairsTrading llc. For the sake of simplicity, let`s assume that the hedge fund does not charge a management fee. Instead, the hedge fund only charges a performance fee of 20% of profit. In addition, the fund uses a high watermark to determine the return fees due. Therefore, investors only have to pay a performance fee for the new profits. Finally, the service fee is billed quarterly. This means that the deep-sea leash is also updated at the end of each quarter.

This is where the deep-sea leash becomes relevant. In the years following the loss in the previous example, you would not be liable for the performance fee until the value of the fund exceeds its previous peak of $1.8 million. As we can see, the fund is doing quite well in the first three months. After that, however, the fund begins to lose money and reaches a low at the end of the 8th month. Nevertheless, the fund still manages to land above the updated high water mark by the end of the year. The following figure shows the evolution of the fund`s assets. The arrows indicate the cases in which the fund manager may charge performance fees. In these cases, the bottom is above the high water mark.

Continuing the example above, we look at the fund`s assets after 6 months. In this case, the current asset is below the updated peak (109.11 > 107.98). This implies that the manager is entitled to a performance fee. After 9 months, the manager is still below the updated high seas threshold. Finally, at the end of the year, the Director General is again entitled to a service fee. He recovered all the losses he suffered between month 3 and the end of the year. Several things can happen when an investor enters a fund during a period of underperformance.