Significant downward pressure has been applied on hedge fund management fees in recent years, but hedge fund incentive allocations - fees paid for the performance of the fund - have remained relatively steady at around 20%, the industry average. However, that stability can change during a period of underperformance. In order to continue operating and also account for investors’ opposition to paying performance fees on losses, some managers have implemented modified high water marks, which allow them to collect a reduced performance fee while the fund remains below its high water mark. Although modified high water marks are not yet commonplace in the hedge fund industry, they have gained increasing acceptance among investors as a workable solution for addressing the practical realities of operating a fund during a bear market or temporary performance slump.
In the article, "Modified High Water Marks: Current Trends, Provisions, Investor Attitudes and Operational Considerations," published in Hedge Fund Legal & Compliance Digest, RK&O partner Kenneth Werner shares his thoughts on the modified high water mark provisions, analyzes the current market for such structures, their benefits, investors attitudes towards them and operational issues managers should look out for when implementing them.