The lack of a single “right” measure for private investment performance has led to inconsistent approaches across the industry and difficulty decomposing the various drivers of performance. Taken together, these measures demonstrate the degree of out/underperformance versus publics (using public market equivalent analysis), the investor’s manager selection skill (using medians and quartile rankings against other funds raised in a similar environment and employing a similar strategy), and the investor’s skill in selecting the right strategies at the right times (through analysis of asset allocation decisions versus custom benchmarks). We have developed a framework that seeks to address this problem by measuring success across a series of key metrics and leveraging a set of tools that can be applied in a consistent manner. The lack of a single “right” measure for private investment performance has led to inconsistent approaches across the industry and difficulty decomposing the various drivers of performance.Given the staggered commitment approach typical of private portfolios, this analysis implies that investors should not attempt to derive much meaning from private portfolio returns and benchmark comparisons until the program is at least eight years old. Based on this analysis, we believe that drawing any conclusions about a manager’s performance earlier than five to six years into a fund’s lifecycle can lead to incorrect conclusions and poor selection of follow-on funds. Funds can shift significantly among quartiles, with 80% to 90% of funds landing in at least three different quartiles through the course of their lives. On average, a fund needs about six years to “settle” into its final quartile ranking versus peers. Private investment funds and corresponding benchmarks require a surprisingly long period of time before they provide any indication of ultimate performance.To put IRRs in context, we recommend always reviewing IRRs alongside cash-on-cash multiples like distributed to paid-in capital and total value to paid-in capital. Nonetheless, IRRs are not perfect measures and investors should keep in mind issues associated with the IRR calculation, including the reinvestment rate assumption and the fact that the IRR can be managed in certain circumstances. Unlike the compounded TWR, an IRR captures the impact of managers’ investment decisions, including when to call and return capital, when to exit, etc. An IRR is a superior indicator of ultimate performance because it looks holistically at the time horizon of interest and considers all cash flows. The two most common measures of investment performance-time-weighted returns (TWRs) and money-weighted returns, typically an internal rate of return (IRR)-differ in meaningful ways.Private investments often play an important role in an investor’s portfolio, yet the inconsistent methodologies typically used to evaluate private investment performance and public market performance result in a lack of understanding about true relative performance.
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