Why a single fund-level high-water mark lets new money ride free after a drawdown, what a depreciation deposit collects, and who bears the difference.
Performance fee equalisation makes each investor pay the fee on its own gain, not on the fund's. Without it, money that subscribes below the high-water mark rides free: in an illustrative evergreen fund with a 12.5 per cent fee and a mark of 100, investors who buy at 90 and see the NAV reach 108 pay 1.00 per unit, 5.56 per cent of their gain, instead of 2.25. A depreciation deposit of 1.25 per unit closes the gap.
Worked in full in The Evergreen Fund Handbook by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Most semi-liquid private markets funds calculate a performance fee at fund level, on one NAV per unit against one high-water mark, crystallised once a year. It is simple and it is what the prospectus usually describes. It is also exact only when every investor joined at the same price. Evergreen funds take subscriptions every month, often heaviest after a drawdown when entry looks attractive, which is precisely when a fund-level mark misprices the fee.
| Input | Value |
|---|---|
| Performance fee on NAV gains above the high-water mark | 12.5% |
| High-water mark and NAV per unit at the start of the year | 100 |
| Existing investors (A): units | 10m |
| NAV per unit at the trough, mid-year | 90 |
| New subscriptions at the trough (B) | 200 |
| Units issued to B | 2.222m |
| Gross NAV per unit at year end, before the fee | 108 |
No hurdle, to keep the arithmetic visible. The fund falls 10 per cent, recovers 20 per cent from the trough and ends 8 per cent above the mark.
Fee per unit = 12.5% × (year-end NAV − high-water mark) = 12.5% × (108 − 100) = 1.00, on all 12.222m units.
Net NAV per unit: 107.00. Total fee: 12.22m.
A gained 8 per unit and paid 1.00: 12.5 per cent. B gained 18 per unit and paid 1.00: 5.56 per cent.
The fund-level mark only sees the NAV per unit. It cannot tell that B's units were bought at 90, so the first 10 of B's 18 of gain, the recovery back to 100, are treated as recovering a loss B never suffered.
A: 12.5% × (108 − 100) = 1.00 per unit, 10.00m.
B: 12.5% × (108 − 90) = 2.25 per unit, 5.00m.
Fees owed: 15.00m. Fees charged at fund level: 12.22m. Free ride: 2.78m, 18.5 per cent of the fees owed.
There are two standard mechanisms. Both leave A exactly where it was.
| Year-end NAV | Fund-level fee | Fee owed by B | Free ride, collected by the deposit |
|---|---|---|---|
| 92 | 0.00 | 0.25 | 0.25 |
| 96 | 0.00 | 0.75 | 0.75 |
| 100 | 0.00 | 1.25 | 1.25 |
| 104 | 0.50 | 1.75 | 1.25 |
| 108 | 1.00 | 2.25 | 1.25 |
| 116 | 2.00 | 3.25 | 1.25 |
The free ride grows with the recovery up to the mark, then stays fixed at the full deposit. Below the mark the fund-level fee is zero while B has made a real gain, which is why the deposit is collected pro rata: 0.75 at a NAV of 96.
The deeper the trough at entry, the larger the distortion. With a year-end NAV of 108, an investor entering at 95 pays an effective 7.69 per cent of its gain under a fund-level fee, at 85 it pays 4.35 per cent and at 80 only 3.57 per cent.
The other direction hurts the existing investors. When B subscribes above the mark while a fee is accrued, and the NAV then falls, the reversal of the accrual is shared across all units, including B's, which never bore it. That transfer comes out of the existing holders' pockets, and the remedy is an equalisation credit: B pays the gross NAV and the accrued fee is held for B, refunded in units as far as the accrual is not used.
The common mistake is to assume a fund-level fee is fair because the fee rate is the same for everyone. The rate is the same; the base is not. After a drawdown, a fund raising heavily at the trough can forgo a fifth of the fee owed on the recovery, and in the reverse case existing holders subsidise newcomers. Whether that is acceptable is a disclosure and fair-treatment decision, but it should be a decision with a number attached, not an accident of the calculation method.
Price the fee investor by investor whenever entry prices differ materially from the high-water mark: a depreciation deposit for subscriptions below it, an equalisation credit above it, or series accounting for both. The fund-level calculation itself, with the hurdle and catch-up, is worked in how an evergreen fund's performance fee is calculated, and the fair-treatment working documents for this book are on the free companion page for this case.
An amount charged to an investor who subscribes below the high-water mark, equal to the fee rate times the distance to the mark, and paid to the manager only if the NAV recovers. Subscribing at 90 against a mark of 100 with a 12.5 per cent fee, it is 1.25 per unit, collected in full at a year-end NAV of 100 or above and pro rata below, 0.75 at 96.
In the below-high-water-mark case, no: existing investors pay the fee on their own gain either way, 1.00 per unit on a rise from 100 to 108 in the illustrative fund. The free ride is paid for by the manager in fees forgone, 2.78m in the worked case. In the opposite case, subscriptions above the mark followed by a fall, existing investors can bear part of it, which is why equalisation credits exist.
Issuing each month's subscribers a separate series with its own high-water mark, set at the subscription price. A series issued at 90 is charged 12.5 per cent of the rise from 90, 2.25 per unit at a NAV of 108 in the illustrative case, and is merged back into the main series once both are above their marks after a crystallisation.
This article is one calculation from The Evergreen Fund Handbook. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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