When you’re entrusting your money to a fund manager, it’s vital to understand how their incentives align with your returns. One of the most important—and sometimes overlooked—mechanisms is the high-water mark. In 2025, as more Australians invest in managed funds, hedge funds, and alternatives, knowing how the high-water mark works can help you avoid unnecessary fees and ensure you’re getting value for money.
What is a High-Water Mark?
The high-water mark is a benchmark used by investment managers to determine when performance fees are payable. In essence, it ensures that managers only earn performance fees on new profits—not on gains that merely recover previous losses. This mechanism protects investors from being charged twice for the same performance and is a standard feature in most Australian managed funds and alternatives, particularly those with variable or incentive-based fee structures.
- Example: If your investment peaks at $100,000, drops to $90,000, then rises to $100,000 again, the manager cannot charge a performance fee until your balance exceeds $100,000.
- Why it matters: Without a high-water mark, managers could be incentivized to take excessive risks or be rewarded for simply recovering previous losses.
How High-Water Marks Work in Practice (2025 Update)
Australian financial regulators, including ASIC, have continued to emphasise investor protection in 2025. Fund managers must clearly disclose their fee structures and how high-water marks are calculated. Recent policy updates have focused on increased transparency and standardisation across the industry.
- Performance Fee Calculation: Suppose a fund charges a 20% performance fee above the high-water mark. If your investment grows from $120,000 (previous high) to $130,000, the manager earns 20% of the $10,000 gain, or $2,000.
- Loss Recovery: If the fund drops to $110,000, the high-water mark remains at $120,000. No performance fees are charged on gains until your investment exceeds $120,000 again.
- 2025 Disclosure Requirements: Under updated ASIC guidance, Product Disclosure Statements (PDS) must include a worked example of the high-water mark calculation, ensuring investors can easily compare offerings.
What to Watch For: Variations and Pitfalls
While the high-water mark is designed to protect investors, not all implementations are created equal. In 2025, Australian investors should be alert to the following:
- Reset Clauses: Some funds include reset provisions, which can lower the high-water mark after a period of underperformance or at regular intervals. This may allow managers to earn performance fees sooner, even if long-term returns lag.
- Crystallisation Frequency: The timing of when performance fees are calculated (monthly, quarterly, annually) can affect how much you pay. More frequent crystallisation can sometimes lead to higher fees in volatile markets.
- Tax Implications: Performance fees, including those calculated with a high-water mark, can affect your after-tax returns. In 2025, with ongoing debate about capital gains tax reform, staying aware of how fees interact with tax is more important than ever.
Ask your fund manager or adviser about these features before investing. Compare the fine print across different funds, and consider how the high-water mark structure aligns with your risk tolerance and investment horizon.
Real-World Example: Australian Fund Performance in 2025
Let’s say you invest in an Australian hedge fund with a 15% performance fee above the high-water mark. Your initial investment is $50,000. Over the next three years, your returns are as follows:
- Year 1: Portfolio grows to $60,000. Performance fee on $10,000 gain = $1,500.
- Year 2: Market downturn drops your balance to $52,000. No performance fee is charged.
- Year 3: Portfolio rebounds to $62,000. New gain above the previous high-water mark ($60,000) is $2,000, so performance fee is $300.
This structure ensures you’re only paying fees on new profits, not on recovery from losses.
Conclusion
In 2025, as managed funds and alternative assets become more popular with Australians, understanding the high-water mark has never been more critical. This mechanism plays a vital role in aligning fund manager incentives with your returns and protecting you from excessive fees. Always review how the high-water mark is structured in any investment you consider, and don’t hesitate to ask for detailed examples before committing your capital.
