If a fund falls from 120 to 100 and then recovers to 120, no performance fee is due on the recovery because the high-water mark is 120. Only gains above 120 attract a fee. High-water marks are tracked per investor or per series, since investors who bought at different NAVs have different marks.
Some funds add a hurdle rate on top, so that a fee is earned only on gains above both the high-water mark and a minimum return. Allocators treat a high-water mark as a minimum standard; its absence is a red flag in due diligence.