High-water Marks And Hedge Fund Compensation

The authors examine the role of high-water mark provisions in hedge fund compensation contracts. In this model of competitive markets and asymmetric information on manager ability, a fee contract with a high-water mark can improve the quality of the manager pool entering the market. In addition, a high-water mark contract can reduce inefficient liquidation by raising after-fee returns following poor performance. Consistent with the model's predictions, they find that high-water marks are more commonly used by less reputable managers, funds that restrict investor redemptions, and funds with greater underlying asset illiquidity. High-water marks are also associated with greater sensitivity of investor flows to past performance, but less so following poor performance.

Provided by: Arizona State University Topic: CXO Date Added: Dec 2009 Format: PDF

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