How the High-Water Mark Fee Model Works in Indian PMS

When investing in Portfolio Management Services (PMS) in India, fee structure has a large impact on final net returns. Unlike public mutual funds, which are restricted to a Total Expense Ratio (TER), PMS providers can charge performance-linked fees.

To protect high-net-worth investors, SEBI has made the High-Water Mark (HWM) model mandatory for all performance-linked fee calculations in India.

If you are looking for a fee-only SEBI Registered Investment Advisor (RIA) to evaluate your PMS agreements and model your net-of-fee returns, Find a Fee Only Investment Advisor.

1. What is the High-Water Mark Model?

The High-Water Mark is a regulatory model for calculating performance fees.

• The Rule: A portfolio manager can only charge a performance fee on new gains that exceed the highest historical value (peak value) that the portfolio has ever achieved.
• The Goal: It ensures that you are never charged a performance fee twice on the same gains, and that the manager must recover previous losses before earning a single rupee of performance fees on new profits.

2. A Real-World Mathematical Example

Let’s trace the fee calculation of a ₹1 Crore portfolio over a three-year period under a 20% performance fee model with a 10% annual hurdle rate (and zero fixed fee for simplicity):

graph TD
    A["Year 1: ₹1.0 Cr Invested"] -->|"Gross 15% Return"| B["Year 1 Peak: ₹1.15 Cr"]
    B -->|"20% fee on the ₹5L gain above hurdle"| C["Year 1 End Net AUM: ₹1.14 Cr"]
    C -->|"Year 2 Market Correction"| D["Year 2 End AUM: ₹90L"]
    D -->|"Year 3 Recovery"| E["Year 3 Gross: ₹1.25 Cr"]
    E -->|"Fee only after HWM and hurdle tests"| F["Year 3 fee depends on the agreement"]

Year 1: Positive Alpha

• Starting AUM: ₹1,00,00,000 (₹1 Crore).
• Hurdle Value (10%): ₹1,10,00,000.
• Year-End Gross AUM: ₹1,15,00,000 (15% gross return).
• Gain above Hurdle: ₹5,00,000.
• Performance Fee (20%): ₹1,00,000.
• Year-End Net AUM: ₹1,14,00,000.
• High-Water Mark for the next calculation: determined under the agreement and SEBI's pre-performance-fee calculation convention; in this simplified example, the relevant pre-fee peak is ₹1,15,00,000.

Year 2: Market Correction

• Starting AUM: ₹1,14,00,000.
• Year-End AUM: ₹90,00,000 (due to a market correction).
• Performance Fee: ₹0 (no gains generated).
• High-Water Mark Status: The prior pre-fee peak remains the reference point. No performance fee is charged in this loss year.

Year 3: Recovery and New Gains

• Starting AUM: ₹90,00,000.
• Year-End Gross AUM: ₹1,25,00,000.
• Gross Gain in Year 3: ₹35,00,000.
• High-Water Mark Check: The portfolio has exceeded the prior pre-fee peak.
• Fee calculation: The exact charge cannot be derived from the peak alone. SEBI's illustration applies the contractual hurdle to the return over the high-water mark, along with fixed fees, brokerage and other expenses. The signed agreement therefore determines the Year 3 performance fee.

[!NOTE] Without the High-Water Mark: The high-water mark prevents a manager from treating the entire recovery from ₹90 Lakhs as fresh performance. The precise saving depends on the hurdle and expense mechanics in the client agreement.

3. Fixed vs. Variable Performance Fee Models

HNI investors typically choose between three fee structures in a PMS:

A. Fixed Fee Only

• Fee: Typically 2.0% to 2.5% p.a.
• Best for: Investors who expect high alpha and want to keep 100% of the returns above the fixed cost.

B. Variable/Performance Fee Only

• Fee: 0% fixed fee, 20% to 25% profit share above hurdle (usually 10%).
• Best for: Investors who want stronger incentive alignment. The manager earns no performance fee if the portfolio fails to beat the hurdle.

C. Hybrid Structure

• Fee: Lower fixed fee (e.g., 1.5% p.a.) plus a lower performance fee (e.g., 15% profit share above 10% hurdle).
• Best for: Balancing alignment with cost control.

FAQ

Is the High-Water Mark mandatory in Indian PMS?

Yes. SEBI requires performance-linked fees to use the High-Water Mark principle over the life of the investment. The performance-fee calculation period is at least one year.

What is a hurdle rate?

A hurdle rate is the minimum return the portfolio manager must generate before they are entitled to charge a performance fee. For example, if the hurdle rate is 10%, the first 10% of returns are completely free of performance fees.

How does cash withdrawal affect the High-Water Mark?

If you make a partial withdrawal from your PMS, the High-Water Mark is adjusted downwards on a pro-rata basis to reflect the capital withdrawn, ensuring the calculations remain fair and mathematically accurate.

Want to evaluate the net-of-fee returns of a prospective PMS contract? Find a Fee Only Investment Advisor →