You’re evaluating your Private Equity investments. What are the most popular performance benchmarking tools?

While IRR belongs to the gold standards in measuring performance, there are some drawbacks to consider. Let's start with the advantages: 1. IRR accounts for the time value of money 2. The result is a clear percentage-based return 3. No need for benchmark data 4. Simple indication of investment attractiveness Keep in mind and try to mitigate the drawbacks: 1. IRR as assumed rate of reinvestment 2. Potential overemphasis on early returns (with returns leveling off in a later phase) 3. Ignorance of scale of investment and no absolute returns To counter those disadvantages, complement the IRR with other metrics, such as MOIC and NPV, consider sector-specific implications, and put the IRR into perspective of the investment horizon.

Utilizing Internal Rate of Return (IRR) as a performance benchmarking tool in evaluating Private Equity investments offers a comprehensive assessment of the fund's profitability over its lifespan. Unlike simple return metrics, IRR considers the timing and magnitude of cash flows, providing a nuanced understanding of investment performance. By calculating IRR, Private Equity professionals can gauge the fund's ability to generate returns relative to the risks undertaken and compare it against alternative investment options or industry benchmarks.

- Easy percentage metrics to evaluate returns - Tells us about investment worthiness - A better comparative mechanism with other investments

Internal Rate of Return (IRR) Public Market Equivalent (PME) Total Value to Paid-In (TVPI) Distributions to Paid-In (DPI) Residual Value to Paid-In (RVPI) Vintage Year Benchmarking Cash Flow Modeling:

Keep in mind that the IRR is not a measure comparable to the rate of return, or CAGR (Compound annual growth rate) in public markets. Even though they are often published side by side.

Unlocking Private Equity insights with Multiple of Invested Capital (MOIC). On my experience, integrating the straightforward metric, Multiple of Invested Capital (MOIC), has streamlined Private Equity evaluations. Quick and easy to calculate, MOIC provides a snapshot of value creation per invested dollar. However, it's essential to recognize its limitations, as it overlooks time value of money and risk-adjusted returns. We've found MOIC to be a valuable initial indicator, guiding rapid assessments while acknowledging the need for a comprehensive evaluation alongside other benchmarks.

It is important to consider Multi-Managers Platforms (Multi-PM) because they have delivered stronger risk-adjusted return than hedge funds. Also, multi-MP have held up well through S&P 500 Downturns. On average, Multi-MP Platforms gained during S&P 500 downturns. It is also essential to check the alpha percentage which is the excess return of an asset not explained by systematic market risk. Also, Beta ration is essential because it presents the fund's volatility relative to the market.

(a) Benchmarking tools often compare private equity returns to public market indices like the S&P 500. Analyzing these correlations helps investors gauge how private equity performs relative to broader market movements (b) Beyond simple return metrics, consider risk-adjusted measures such as the Sharpe ratio and the Sortino ratio. These ratios account for investment risk and provide insights into the efficiency of returns (c) Benchmarking against peer group performance can be valuable. It allows you to assess whether your investments are outperforming or underperforming similar funds or strategies.

(a) To gauge the effectiveness of investment strategies over time, I have utilised MOIC to compare current investments against the historical performance of the fund. This longitudinal analysis has been instrumental in identifying trends, informing strategy adjustments & driving continuous improvement in fund performance (b) In scenarios involving co-investments with other firms or investors, MOIC has served as a common language for evaluating & discussing investment opportunities. This shared metric has facilitated collaboration, aligning expectations & objectives among co-investors (c) In aligning the interests of fund managers with those of investors, MOIC has played a key role in the design of performance-based compensation structures

When sizing up Private Equity investments, another tool in our kit is the Multiple of Invested Capital (MOIC). It's like checking the growth rate of a savings account – a straightforward measure of value creation. MOIC calculates the ratio of the fund's total value (gains included) to the capital initially invested. It's like figuring out how much bang we get for every buck invested. But, it's a bit like glancing at the surface; it doesn't consider time value or risk-adjusted returns, sort of like gauging the growth without factoring in the interest rate or potential ups and downs.

Here are three key points about using Public Market Equivalent (PME) as a performance benchmarking tool for Private Equity investments: • PME compares the returns of a private equity fund to a public market index like the S&P 500. It calculates what the returns would have been if the same capital was invested in the public markets instead. • There are different PME methodologies like Long-Nickels PME, Kaplan-Schoar PME, and Direct Alpha PME. Each uses slightly different formulas. • PME helps assess if the private equity fund is providing returns higher than what could have been earned by simply investing in public equity markets. It accounts for differences in cash flow timing between private and public equities.

With PME, we're not just looking at our fund's performance but asking, "What if we took the public market route instead?" It's like considering alternate paths and calculating returns based on indices like the S&P 500. Much like choosing the best GPS for accuracy, PME has different formulas – Long-Nickels, Kaplan-Schoar, or Direct Alpha – allowing us to fine-tune our navigation and get a clearer picture of our investment journey.

Quartile ranking in Private Equity evaluates fund performance relative to peers, aiding in benchmarking and risk assessment. Top quartile funds typically signify strong returns and lower risk, influencing portfolio optimization and investment decisions. This approach provides a succinct yet comprehensive method for communicating performance nuances to stakeholders in the dynamic Private Equity landscape.

There's a running joke amongst Private Equity LPs that all funds are in the top quartile. That's because it's easy for marketers can choose between many datasets that suit them.

Quartile ranking divides fund returns into four equal parts: the top quartile (best 25% performers), the second (above-average), the third (below-average), and the bottom quartile (lowest 25%). It's a key method in finance for comparing fund performance relative to peers.

(a) Analysing PE fund performance based on their vintage year, or the year in which the fund made its first investment, allows for comparison within the context of market conditions at the time of investment. This approach has helped me contextualise fund performance against market cycles, offering a nuanced understanding of performance relative to market conditions at the time of investment (b) Utilising broad PE index benchmarks, such as those provided by Cambridge Associates or Preqin, offers a way to compare fund performance against a wider industry aggregate. In my evaluations, these benchmarks have been valuable in understanding how individual funds or investments stack up against the broader PE industry performance.

When evaluating Private Equity investments, consider factors like risk profile, investment horizon, fund manager track record, market conditions, sector and geographic exposure, fee structure, alignment of interests, liquidity needs, regulatory and tax implications, as well as environmental, social, and governance (ESG) factors.