A hurdle rate versus a high-water mark

The fee structure in PMS (portfolio management service) or AIF (alternative investment fund) space may include two primary components–management fee and the performance fee.

The management fee is charged irrespective of the returns charged by the fund and is usually a fixed annual percentage of the net asset value of the fund.

While the performance fee can be determined in various ways, it includes having a hurdle rate or both a hurdle rate and a high-water mark. The hurdle rate implies the minimum rate of return mandated by an investor or a fund manager to charge performance fee.

Munish Randev, founder and chief executive of CERVIN Family Office, explains this with an example of a fund that has a high-water mark with a hurdle rate of, say, 10% and an initial investment of ₹100. The performance fee is triggered only when that investment goes beyond ₹110 ( ₹100+ ₹10 hurdle). With high-water mark, the fund cannot charge the next performance fee until the investment goes beyond ₹110. If the investment value drops in the second year to ₹80 and delivers 30% in the third year to take the investment to ₹104, no performance fee can be charged in the third year though it has beaten the hurdle rate of 10%. This is because ₹104 is still lower than ₹110. Thus, high-water mark ensures that fee is not paid on the same value of investment return when recovering from losses.