The greatest value reached by an investment fund that, in the event of a decrease in fund value, must be reached again before a hedge fund manager can take a performance fee. It ensures that if the value of the fund falls from one investment period to the next, an investor will not pay a performance fee until the fund's value exceeds its previous greatest point. High water marks prevent hedge fund managers from receiving performance compensation for poor or volatile performance.

For example, assume that an investor invests $100,000 in a hedge fund that charges a 20% performance fee. During the next period, the fund earns a 25% return so that the investor's account is worth $125,000. The investor will owe the hedge fund manager a $5,000 performance fee (the $25,000 gain x 20%). However, if the value drops to $75,000 in the following period, the hedge fund manager will not receive a performance fee again until the fund's value exceeds $125,000.