High-Water Marks After a Down Year
On 1 April 2023 a client invested ₹1,00,00,000 in a discretionary multi-cap strategy. The fee schedule is a 1% annual management fee, billed separately, plus a performance fee of 20% of the increase in portfolio value above the high-water mark, crystallised and billed every 31 March. FY2023-24 gross return was +25%; a performance fee of ₹5,00,000 was paid and the high-water mark was reset to ₹1,20,00,000 on 31 March 2024. FY2024-25 gross return was −5%, leaving the portfolio at ₹1,14,00,000, and no performance fee was charged. On 1 April 2025 the client added ₹25,00,000 of fresh money. FY2025-26 gross return was +18%. On 3 April 2026 the relationship manager asks to bill "the full 20% of the 18% gain, plus a catch-up for the loss year", and wants to move performance-fee billing to a quarterly cycle because the portfolio is "well ahead".
1. Compute the performance fee payable for FY2025-26, showing how the fresh investment is treated.
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The fresh money is not performance and must not attract a fee. Opening value for FY2025-26 is ₹1,14,00,000 plus ₹25,00,000, i.e. ₹1,39,00,000. The high-water mark must be adjusted by the same contribution: ₹1,20,00,000 + ₹25,00,000 = ₹1,45,00,000. Closing value is ₹1,39,00,000 × 1.18 = ₹1,64,02,000. The excess over the adjusted high-water mark is ₹19,02,000, so the fee is 20% of that, i.e. ₹3,80,400. Cross-check by components: on the old money, ₹1,14,00,000 grows to ₹1,34,52,000, an excess of ₹14,52,000 over the ₹1,20,00,000 mark; on the new money, ₹25,00,000 grows to ₹29,50,000, a gain of ₹4,50,000. Together ₹19,02,000, again ₹3,80,400. If the high-water mark were left unadjusted at ₹1,20,00,000, the manager would charge 20% on the client's own contribution - an obvious overcharge the client's auditor would flag.
2. The RM wants 20% of the whole 18% gain plus a catch-up charge for the loss year, billed quarterly. Assess both requests.
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Both are wrong. The high-water mark is the mechanism that makes the manager wait until the portfolio has regained its previous peak before sharing in gains; the −5% year is borne entirely by the client and is not recovered through a later "catch-up". Charging 20% of the full 18% would effectively levy a fee on the recovery of the client's own prior loss, and the number would be far above the contractual ₹3,80,400. The symmetry matters: because there is no clawback of fee already paid in a loss year, there can be no retroactive top-up afterwards. On quarterly billing, the agreement specifies 31 March crystallisation; the manager cannot unilaterally change a disclosed fee term. Quarterly billing on unrealised, reversible gains can leave the client having paid for value that later disappears, which is precisely why performance fees are crystallised at defined intervals. Any change requires the client's informed written consent, an amended agreement, and consistency with the disclosed fee structure and the high-water-mark basis. Until then, the 31 March computation stands.
3. Suppose instead the client had redeemed half the portfolio on 30 September 2025. How should the performance fee and the high-water mark be handled?
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A partial redemption is a crystallisation event for the portion withdrawn, if the agreement so provides. The manager computes the excess of the portfolio value over the high-water mark at that date, pro-rates it to the redeemed share, charges 20% on that portion, and delivers the net proceeds within 10 working days of a valid request, subject to any exit load disclosed in the disclosure document. For the remaining portfolio the high-water mark is reduced proportionately to the amount withdrawn, so that the same gain cannot be charged twice: once on exit and again at year end on the full position. Worked on the numbers as they stood before the year-end gain, the mark would fall from ₹1,45,00,000 to roughly ₹1,32,50,000 for a 50% withdrawal, and the year-end fee would be computed only on the residual units' excess over that reduced mark. The statement given to the client should show the mark before and after, the crystallised fee, and the exit load computation, so the arithmetic is auditable.