An investor gives a hedge fund $500k in 2010 and that investment's value falls to $300k. In 2011 the hedge fund produces 100% returns and that investment is now worth $600k. This individual would have to pay performance fees based on the gain of ______ in 2011.

A. $100k.
B. $200k.
C. $300k.

Correct Answer: A

In this case, the investor would only have to pay performance fees on that gain between the $500k and $600k, not the full 100% gain ($300k) for 2011.

With a high water mark, though, the manager may just close the fund if it makes a big loss. As long as the fund manager does not have a large investment in the fund, it is not always easy to resist the temptation to take large risks.