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# High Water Mark (HWM) calculation

Discussion in 'Professional Trading' started by chaffcombe, Jan 10, 2007.

1. ### chaffcombe

It's strange, but some things in this business seen flaming obvious on the surface, but when you scratch the surface, they are not!

My question is about HWM calculations where there are (proportionally large) deposits and withdrawals involved. Does anyone know if there is an industry consensus on how to do this, and what it is? There seems to be two basic approaches to the calculation - 'dollars' or 'percentage' - but as far as I can tell, both raise issues.

Simple example:

Starting Balance 100,000
Profit 5,000
Perf Fee (20%) -1,000
HWM 104,000
New Deposit 900,000
New Balance 1,004,000

conversely

Starting Balance 1,050,000
Loss -50,000
Perf Fee (20%) 0
HWM 1,050,000
Withdrawal -900,000
New Balance 100,000

Really appreciate any input.

2. ### chaffcombe

Maybe I should clarify what my initial thoughts are here:

In the first case (deposits) the most logical answer seems to be 1,004,000 which is simply previous HWM + Deposit

However, in the second case (withdrawal) the correct answer seems to me to be the proportional one of \$105,000, rather than \$150,000 which one would get through the addition/subtraction method.

If this is true, the calculations are asymmetric, depending on whether it's a deposit or withdrawal, and that seems unusual to me. Then again performance fees are asymmetrical anyway, so maybe that's the issue.

3. ### mokwit

In practice it is more likely that a HF will close the fund and open another new one to circumvent HWM agreement.

4. ### gnome

Perhaps the best way to determine HWM is to come up with a Unit Asset Value like an open end mutual fund. That way, the amount of money going in or out never makes any difference.

Only when the UAV makes a new high would the manager be entitled to a participation in profits.

5. ### chaffcombe

gnome,

I could well be missing something here, but I'd have thought that even if a Unit Asset Value was calculated, the same issue arises?

What would your calculations be in the above two examples, using an UAV approach?

Many thanks

6. ### gnome

Can't help with your example... the approach is all wrong. Here's how you can do it.

1. Assign each unit a value... like \$100.
2. Each investor would own "X" units @ \$100/unit.

So, let's say you start with \$100,000, then there would be 1000 units owned by the investors.

At the end of month, the value of the fund was \$110,000.

Profit incentive is 20% of \$10,000, or \$2,000.

That leaves \$108,000 and the new UAV is now \$108.

You should take in new money only at the end of the month after the new UAV is calculated.

If new money comes in, divide the amount by \$108 = new units purchased.

Manager would be entitled to profit participation again only when UAV exceeds \$108 at an EOM calculation.

7. ### MGJ

Example 1
Starting Balance 100,000
Profit 5,000
Perf Fee (20%) -1,000
HWM 104,000
New Deposit 900,000
New Balance 1,004,000

Example 2
Starting Balance 1,050,000
Loss -50,000
Perf Fee (20%) 0
HWM 1,050,000
Withdrawal -900,000
New Balance 100,000

I would recommend the returns ("percentage") method. Returns should be calculated as often or more often than deposits and withdrawals are permitted. If deposits can occur monthly, calculate returns montly or faster. If deposits can occur daily, calculate returns daily or faster.

Example 1 starts at 1.00 units at time T0 and grows to 1.04 units at T1 (before deposits or withdrawals). The return during the first period is 4%. Since the highest value ever seen is 1.04 (at T1), the HWM is the fund value at time T1 (after deposits or withdrawals). In dollars, HWM=1,004,000.

Example 2 starts at 1.00 units at time T0 and falls to 0.952381 units at time T1 (before deposits or withdrawals). The return during the first period is -4.7619%. Since the highest value ever seen was 1.00 (at T0), and since the fund is now down 4.7619%, the HWM is the fund value at time T1 (after deposits or withdrawals), multiplied by (1.00/0.952381). That's how much it would need to grow to get back to the highest value ever seen. In dollars, HWM=105,000.

However in the real world, it isn't you that performs these calculations anyway. It's your fund Accountant ("administrator") and she/he uses debugged, validated, certified software to compute the numbers. And even if you disagree, tough. They're the CPA.

8. ### chaffcombe

MGJ,

Got it! Your figures agree exactly with what intuitively made sense to me, yet you have been able to provide a logical and consistent (symmetric) method of getting there.

That was the bit that was escaping me.

Thanks once again.

Here is what I have, with smaller numbers. Please let me know if these calculations are right.

Let's assume the account was opened in December 2006 with \$5,000.

To Calculate December 2006 Incentive Fee:

Previous Balance \$5,000.00
Ending Balance \$5,095.50
Previous High Water Mark \$5,000.00
Trading Profit / Loss for Month \$95.50 (\$5,095.50 - \$5,000.00)
25% Incentive Fee \$23.88 (25% x \$95.50)
New High Water Mark \$5,071.63

At the beginning of January 1st, the customer wants to take out the profits from the trading account and pay the incentive fee from their own checking account instead of removing it from the trading account.

To Calculate January 2007 Incentive Fee at the end of the month:

Previous Balance \$5,095.50
Ending Balance \$5,100.00
Previous High Water Mark \$5,071.63
Cash Adjusted Balance \$5,195.50 (\$5,100.00+ \$95.50)
Trading Profit / Loss for Month \$123.87 (\$5,195.50 - \$5,071.63)
25% Incentive Fee \$30.97 (25% x \$123.87)
New High Water Mark \$5,069.03

Please let me know what you think of this method.

Thank you.

10. ### Aaron

Looks good to me.

The harder calculation is the highwater mark after a drawdown and then a withdrawal. Try that one...

Aaron Schindler