Explainer: Private Equity as an Asset Class

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Private Equity as an Asset Class

Private equity (PE) as an asset class (including single investment structures and venture capital) has the potential to generate sustained, long-term outperformance for its investors.

As an administrator, we use our experience to help managers and investors alike in understanding the complexities of the PE space. We understand that not all investors are familiar with this asset class, making it a challenging proposition to investors who are otherwise more accustomed to the liquidity, information flow and timing associated with the public market. We that find our knowledge around effective performance metrics is helpful to new managers and investors navigating the area.

We have put together this short explainer for those new to the asset class covering:

Key Features of Private Equity

Defining features of PE include:

  • The investment vehicle can be either: a single investment structure (SIS); or a collective investment housing several private investments (Fund).
  • Usually for structural reasons, both the SIS and / or Fund will take the form of a limited partnership.
  • In a limited partnership structure, investors are called limited partners (LPs). This term is broadly used in private equity terminology as a result.
  • In a limited partnership structure, the SIS or Fund is operated by a general partner (GP)
  • Structures tend to have GPs, managers (in some cases these are one and the same), administrators and auditors (as would hedge funds) in order to preserve the separation of duties, prevent conflicts of interests, and to provide third party checks and balances.  Generally, there is not a custodian owing to the nature or type of the assets.
  • An LP (investor) will make a defined cash commitment on the terms of an offering document, which may be called during the investment period in tranches.
  • Capital calls are generally made for investment or administrative purposes, and are mostly irregular (meaning that LPs need to have cash available to pay).
  • These unique characteristics, including the irregular timing and  size of cash flows, make measurement of returns far from straightforward and difficult to benchmark against other asset classes.

As a consequence of these unique features, it is not a straightforward exercise for an investor to benchmark their PE holdings against those of other asset classes. To cater for this, alternative metrics have been adopted to give investors the greatest possible understanding of their PE performance compared to that of their other asset classes.

Comparing PE with Public Equity Portfolios

Stakeholders may wish to compare PE funds’ performances with that of more traditional asset classes.  Unfortunately, it is not that simple.  Unlike listed or traded instruments, much of PE’s performance reporting relies on interim valuations of unlisted and illiquid investments, making precise “mark-to-market” impossible.   Further, unlike public markets where building a diversified portfolio is standard practice, diversification is not generally an objective for PE.

PE Performance Measurement

Performance in PE investing is traditionally measured via (i) the internal rate of return (IRR) which captures a Fund’s time-adjusted return, and (ii) multiple of money (MoM) (also known as multiple on invested capital (MOIC)), which captures return on invested capital. Only once all investments have been exited and the capital returned to LPs, will the final return determine the Fund or SIS’s standing amongst its peers.

Let us take a look at the industry standard metrics employed by GPs and LPs to arrive at a meaningful assessment of a Fund’s success.

Internal Rate of Return

The IRR is a metric used to measure and compare returns on an investment. IRR calculates the return by including all of the cash flows from the investment over a given period, taking into account drawdowns, distributions (such as capital gains), income (through dividends), and valuation of residual value. IRRs are most often used by the PE industry to measure returns, because they offer a means of comparing two investments with irregular timings and sizes of cash flows. They are, unfortunately, a measure that is not directly comparable to the buy and hold returns that can be found in the public markets.

A quick summary:

  • The IRR metric allows for irregular cash flows to be analysed, permitting comparison between investments of different asset classes.
  • The IRR considers the time value of money and represents the discount rate that renders the net present value (NPV) of a series of investments zero.
  • The actual calculation is relatively simple, with the assistance of a computer, and straight forward to interpret.

Some shortcomings to be aware of:

  • The IRR assumes that cash flows are reinvested at the same rate of return. This can lead to the over or understatement of the performance of a given investment.
  • The IRR is not an effective way of assessing mutually exclusive projects, particularly where two projects absorb significantly different amounts of capital, but, for example, the smaller project has a higher IRR.
  • Management fees can distort IRR so that gross returns tend to be more representative of the true performance.  Assumptions and adjustments are generally made to accommodate.
  • Investors should exercise care when understanding whether a presented metric is gross or net.

Money Multiples

A private equity Fund’s MoM or MOIC provides a cash-on-cash measure of how much investors are receiving. They are calculated by dividing the value of the returns by the amount of money invested. Two multiples that are typically reported by Funds are (i) distribution to paid-in capital (DPI) and (ii) total value to paid-in capital (TVPI), which differ in terms of whether or not they include residual value to paid-in ratio (RVPI). In summary, TVPI = RVPI + DPI.

Multiples are often used in the PE industry as they offer an easy way to show the scale of the returns an investment has given. While the IRR provides useful ways of showing returns from an investment, they cannot provide a scale of returns without knowing the length of time of the fund. Multiples, however, offer a fast and easy way to show this, and when used in conjunction with the IRR, can paint a quick and clear picture of a Fund’s performance. It is convention in the industry to show TVPI and DPI on a net basis.

Uses and strengths:

  • Multiples offer a quick and readily digestible means of indicating the performance of a Fund. Any multiple above 1 shows that that the Fund has returned more than its initial investment.
  • They also offer a way for projects of different scales to be compared. As returns are expressed as a proportion rather than as an absolute figure, investments of different sizes can be easily compared.


  • Multiples ignore the time value of money.
  • The metric is also less useful when comparing investments in their early stages. When drawdowns are still being made, multiples can be highly variable, reducing their usefulness. As such, they are most relevant as a Fund matures.
  • While multiples are good at showing returns as a proportion, they do not provide an indication of the scale of the project nor of the size of the absolute returns.
  • It is also possible that when looking at multiples on a fund basis, one large deal can have a disproportionately large positive or negative impact on a blended basis.
  • As with IRR and other performance metrics, investors should exercise care when understanding whether a presented metric is gross or net.


The widely used IRR and MoM return measures are effective metrics, however it would be fair to say that each has its own flaws inherent in the difficulty in measuring PE performance.

No single measurement represents the right or wrong way of measuring the performance of PE and venture capital investments. Investors and fund managers may find that different combinations of these metrics will work best for them in assessing their PE and venture capital investments, and that they are best placed to take a view on this.

The relationship between the absolute and the market-adjusted performance measures is summarised here:

Rate of ReturnTotal Return
Absolute ReturnIRRMoM (TVPI)

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