This one of a series of posts on fund performance metrics. Other posts in this series include:
We have now discussed the three metrics that are primarily used to evaluate the performance of private equity funds: (1) the multiples TVPI, DPI and RVPI; (2) IRR; and (3) PME. We will now discuss how to use these metrics to evaluate the performance of private equity funds.
Overview
There are several ways to evaluate the performance of a fund, or a portfolio of funds, with the main methods being:
Absolute Return
Absolute return refers to a specific threshold requirement for a fund’s performance. For example, some LPs may say that they expect a 3.0x TVPI and 30% IRR net return from early stage venture capital funds, or a 2.0x and 20% return for buyout funds. If a fund’s return exceeds these metrics, then it “outperforms” the metrics. If a fund’s returns are less than these metrics, then the fund “underperforms.”
A note about absolute return. Most funds experience a J-Curve, where performance declines in the first couple of years of a fund when fund expenses and investment losses exceed investment gains, but the fund’s performance improves over the next several years. The J-Curve is more pronounced for early-stage venture capital funds. The J-Curve looks something like this:
- LP Corner: Private Equity Fund Performance – An Overview
- LP Corner: Fund Performance Metrics – Multiples TVPI, DPI and RVPI
- LP Corner: Fund Performance Metrics – Internal Rate of Return (IRR) – Part One
- LP Corner: Fund Performance Metrics – Internal Rate of Return (IRR) – Part Two
- LP Corner: Fund Performance Metrics – Public Market Equivalent (PME)
- LP Corner: Fund Performance Metrics - Private Equity Fund Performance - This blog post.
- LP Corner: Gross vs Net Returns
We have now discussed the three metrics that are primarily used to evaluate the performance of private equity funds: (1) the multiples TVPI, DPI and RVPI; (2) IRR; and (3) PME. We will now discuss how to use these metrics to evaluate the performance of private equity funds.
Overview
There are several ways to evaluate the performance of a fund, or a portfolio of funds, with the main methods being:
- Absolute return.
- Comparative return to other similar funds (Quartile Analysis).
- Comparative return to the public markets (PME Analysis).
Absolute Return
Absolute return refers to a specific threshold requirement for a fund’s performance. For example, some LPs may say that they expect a 3.0x TVPI and 30% IRR net return from early stage venture capital funds, or a 2.0x and 20% return for buyout funds. If a fund’s return exceeds these metrics, then it “outperforms” the metrics. If a fund’s returns are less than these metrics, then the fund “underperforms.”
A note about absolute return. Most funds experience a J-Curve, where performance declines in the first couple of years of a fund when fund expenses and investment losses exceed investment gains, but the fund’s performance improves over the next several years. The J-Curve is more pronounced for early-stage venture capital funds. The J-Curve looks something like this:
For more on the J-Curve, see my post: “LP Corner: The J-Curve.”
The point here is that using absolute returns are really only useful late in a fund’s life or after the fund is liquidated. If one were to apply a 20% absolute return metric to the fund in the J-Curve example above, the fund would underperform all years until the last year in the graph.
To read more, please click "Read More" to the right below.
The point here is that using absolute returns are really only useful late in a fund’s life or after the fund is liquidated. If one were to apply a 20% absolute return metric to the fund in the J-Curve example above, the fund would underperform all years until the last year in the graph.
To read more, please click "Read More" to the right below.
