Hedge fund managers unable to subsist entirely on management fees may risk losing key investment personnel without receiving (and therefore being able to offer key people part of) any incentive compensation. Traditional high water mark provisions – which prevent hedge fund managers from receiving any incentive or performance fees until prior losses are recouped – can result in managers going years without performance compensation, even after they have begun to turn the fund’s performance around. To alleviate this pressure, some managers may consider using modified high water mark provisions, allowing them to receive lower amounts of incentive compensation during periods when the fund remains below its high water mark. However, such provisions are not common in the hedge fund industry and may impact the marketability of the manager’s fund, especially as investors continue to place increasing pressure on hedge fund fees. See “Deutsche Bank Alternative Investment Survey Explores Fees and Liquidity Trends, the Landscape for Investment Intermediaries and Early Stage Investment Terms (Part Two of Two)
,” Hedge Fund Law Report, Vol. 8, No. 22 (Jun. 4, 2015). This second article in a two-part series discusses the industry prevalence of and investor reception to modified high water marks and examines issues that hedge fund managers should consider before implementing a modified high water mark. The first article
analyzed elements of modified high water mark provisions and explored the benefits of such provisions.