What does a high watermark refer to in hedge fund performance evaluation?

A high watermark in hedge fund performance evaluation refers to the highest net asset value (NAV) that a fund has achieved at any point in time in relation to the calculation of incentive fees. This concept is integral to ensuring that fund managers are only compensated through performance fees when they generate returns above their prior best level, fostering alignment of interests between fund managers and investors. When a hedge fund incurs losses, the high watermark is not reset; the fund must first recover to its previous highest NAV before any new performance fees can be taken. This structure prevents fund managers from earning performance fees during periods of underperformance, providing investors with a safeguard against paying fees for value that has not been generated.

The other options represent different financial metrics but do not accurately capture the specific meaning of a high watermark within the context of incentive fee calculations in hedge funds.