High Watermark Adjustment after Client Partial Withdraw?

[bhf]

Say, if I manage one client's money and successfully bring its account balance from $10K to $1M, and certainly during the course I have also increased the trade size.

And now because of some drawdown the account dipped to $800K, that means I have a $200K gap to fill before I can continue to enjoy any performance fee. This is a normal drawdown so I did not expect this to be a problem.

However, the client then decide to withdraw $790K from the account, leaving it back to the original $10K balance. With the much reduced account balance I won't be able to trade the size any more, and it seems it is unlikely, if not impossible, for me to fill the $200K gap to high water mark from this small balance.

Is this how you calculate high water marks if you manage OPM? Should the high water mark be readjusted a certain percentage after client withdraw?

 

[Scataphagos]

Quote from bhf:

Say, if I manage one client's money and successfully bring its account balance from $10K to $1M, and certainly during the course I have also increased the trade size.

And now because of some drawdown the account dipped to $800K, that means I have a $200K gap to fill before I can continue to enjoy any performance fee. This is a normal drawdown so I did not expect this to be a problem.

However, the client then decide to withdraw $790K from the account, leaving it back to the original $10K balance. With the much reduced account balance I won't be able to trade the size any more, and it seems it is unlikely, if not impossible, for me to fill the $200K gap to high water mark from this small balance.

Is this how you calculate high water marks if you manage OPM? Should the high water mark be readjusted a certain percentage after client withdraw?

Easy way is to account for your performance like a mutual fund. That is, convert investor funds into "units"... say, you decide to start from $10.00/unit. When a client invests $100,000, you also record the investment as "10,000 units". When client withdraws money, he also withdraws units. That way your new high water mark will be when your unit value hits a new high, regardless of however much money you have under management.

 

[bhf]

But with the decreased trading power it will be more difficult to recover from a drawdown. When you have 1M to trade, recover 100K loss will be easier if you now left with only 10K to trade? This will be unfair to the manager.

Quote from Scataphagos:

Easy way is to account for your performance like a mutual fund. That is, convert investor funds into "units"... say, you decide to start from $10.00/unit. When a client invests $100,000, you also record the investment as "10,000 units". When client withdraws money, he also withdraws units. That way your new high water mark will be when your unit value hits a new high, regardless of however much money you have under management.

 

[newwurldmn]

You don't have to make 100k.

The investor initially bought 1,000 shares at $10/piece. The shares became worth $1,000/piece.
They shares had a drawdown and are now $800/piece. He redeemed 987 shares at $800/piece.
The 13 shares left are worth $800/piece. When they get to $1000/piece then you can start charging performance fees (a 25% return).

If instead of redeeming, he were to buy new shares at 800/piece then those shares would be able to charge management fees now.

 

[Scataphagos]

Quote from bhf:

But with the decreased trading power it will be more difficult to recover from a drawdown. When you have 1M to trade, recover 100K loss will be easier if you now left with only 10K to trade? This will be unfair to the manager.

If you use "units", you don't have to be concerned about "Number of Dollars" in any way.

 

[Scataphagos]

Quote from newwurldmn:

You don't have to make 100k.

The investor initially bought 1,000 shares at $10/piece. The shares became worth $1,000/piece.
They shares had a drawdown and are now $800/piece. He redeemed 987 shares at $800/piece.
The 13 shares left are worth $800/piece. When they get to $1000/piece then you can start charging performance fees (a 25% return).

If instead of redeeming, he were to buy new shares at 800/piece then those shares would be able to charge management fees now.

Don't think so. The manager shouldn't be able to make bonus incentive fee until "units" make a new high water mark. Otherwise, manager would have to keep track of "high water mark per customer"... And then that bonus would have to be charged to each customer individually rather than the pool in general.

 

[newwurldmn]

Quote from Scataphagos:

Don't think so. The manager shouldn't be able to make bonus incentive fee until "units" make a new high water mark. Otherwise, manager would have to keep track of "high water mark per customer"... And then that bonus would have to be charged to each customer individually rather than the pool in general.

Then investors can get a free ride?

Invest in Citadel when they are down 50%, when they double your money, pull out.

And it's possible to track "high water mark." Admittedly, the last part was based on some speculation.

 

[Scataphagos]

Quote from newwurldmn:

Then investors can get a free ride?

Invest in Citadel when they are down 50%, when they double your money, pull out.

In a sense... good for business. Good PR to be able to tell existing customers and potential new ones... "No bonus fee until units make a new high water mark".

And in your case... if investors came in when the units were down 50%, then doubled the value to 100%, how many would be in a rush to pull their money out just to save "incentive fee in the future"? (Not accounting for the fact that after you've just shown your incompetence by losing 50% of your customers' money... investors will want to invest with you.)

Bottom line... make money and treat customers well... and the manager will be amply rewarded.

Your line of thought is that of managers who struggle, lose money for customers, then rationalize how they might legally get away with dinging customers for a few more bucks before they leave. You won't win that way.

 

[newwurldmn]

Quote from Scataphagos:

In a sense... good for business. Good PR to be able to tell existing customers and potential new ones... "No bonus fee until units make a new high water mark".

And in your case... if investors came in when the units were down 50%, then doubled the value to 100%, how many would be in a rush to pull their money out just to save "incentive fee in the future"? (Not accounting for the fact that after you've just shown your incompetence by losing 50% of your customers' money... investors will want to invest with you.)

Bottom line... make money and treat customers well... and the manager will be amply rewarded.

Your line of thought is that of managers who struggle, lose money for customers, then rationalize how they might legally get away with dinging customers for a few more bucks before they leave. You won't win that way.

There's a difference between your own marketing plan, the business decisions you think are right, and the industry norm. What's the industry norm?

 

[Scataphagos]

Quote from newwurldmn:

There's a difference between your own marketing plan, the business decisions you think are right, and the industry norm. What's the industry norm?

I don't think there is an industry norm. CPOs can set parameters for when funds can be withdrawn... and sometimes limit new investments to the beginning of the year only when assets are pooled.

Of course you can keep all records for each account separately and each will have its own high water mark... but you'll likely be swamped with paperwork.

Let's say you have 100 customers. Do you really want to enter 100 separate trades so that each customer gets a specific fill? Along with that, you have to figure a way to juggle the priority of "who gets filled first/last" on each trade so that the entire group of your customers is treated as equally and fairly as possible. Same is true if you make a "block" trade for all customers when the fill is at more than one price. You have to allocate the best fills so that the group is treated as fairly and equally as possible.... that would drive you nuts. The Regulators WILL hold you to this.

I suggest making things administratively easy on yourself... pool assets and account for customer interests in your pool by units... then you don't have to keep account for allocating split price fills.