High-Water Mark vs. Hurdle Rate: What’s the Difference?

Excessive-Water Mark vs. Hurdle Fee: An Overview

Hurdle charge and high-water mark are two kinds of benchmarks that hedge funds can set as necessities for accumulating incentive or efficiency charges from buyers.

A high-water mark is the best worth that an funding fund or account has ever reached. A hurdle charge is the minimal quantity of revenue or returns a hedge fund should earn earlier than it might probably cost an incentive charge.

Excessive-Water Mark

Setting a high-water mark is a approach to guarantee that a hedge fund supervisor is not getting paid as a lot as they’d for a high-performing fund if the fund’s efficiency is poor. If the fund is dropping cash, then the supervisor has to get it above its high-water mark earlier than receiving a efficiency bonus.

Hurdle Fee

A hurdle charge has an identical operate. If a hedge fund units a 5% hurdle charge, for instance, it is going to solely accumulate incentive charges in periods when returns are increased than this quantity. If the identical fund additionally has a high-water mark, it can’t accumulate an incentive charge except the fund’s worth is above the high-water mark, and returns are above the hurdle charge.

Particular Concerns

A hedge fund is a enterprise partnership or another construction that swimming pools and actively handle investments. Below a system referred to as 2/20, hedge funds generally cost administration charges of 1% to 2% of a fund’s internet asset worth (NAV) and incentive charges of 20% of the fund’s income.

The administration charge is at all times paid by the investor, no matter income. Nevertheless, quite a lot of constructions can be utilized in calculating income for the aim of charging incentive charges. Below one sort of construction, the revenue can merely be outlined as the rise in internet asset worth. Alternatively, the revenue could be the rise in NAV with an adjustment for administration charges.

Excessive-Water Mark vs. Hurdle Fee Instance

When utilized in capital budgeting, a hurdle charge has a barely completely different which means—it’s the minimal that the corporate or supervisor expects to earn when investing in a challenge. Hurdle charge may also confer with the bottom charge of return on an funding that might make it a suitable danger for the investor.

On the whole, an funding is taken into account sound if an anticipated charge of return is above the hurdle charge. That additionally implies that an investor might not wish to transfer ahead if the speed of return falls beneath the hurdle charge.