Performance measurement and reporting

The most common measure of performance within the Private Equity industry is the Internal Rate of Return (“IRR”).

a. Fund Net IRR

This measures the return earned by the investors in the fund, and takes account of:

• The actual cash inflows and outflows which take place between the fund and all the LPs;
• The LPs’ share of the fund’s remaining net assets, which includes the valuation of the unrealised portfolio, cash and other net assets or liabilities, after an appropriate accrual for carried interest.

When the portfolio is fully realised/fully distributed, the fund net IRR reflects the ‘cash-on-cash’ return to the investors, and will implicitly be net of:

• The management fees paid to the fund manager (whether funded from investor Capital Calls or out of investment income);
• The fund manager’s carried interest;
• All other applicable professional and ancillary charges which are paid out by the fund in the course of investing, managing, and divesting from the investment portfolio.

The fund net IRR should accordingly represent a “blended” net IRR of all the investors. It is noted that this figure may be greater than or less than the net IRR attributable to an individual investor.

b. Fund Net IRR modified for Bridge Finance/Fund Leverage

The net IRR calculated as if Capital Calls from LPs had been made on the date Capital Calls were made on the Bridge Finance facility, rather than the date Capital Calls were made from LPs, adjusting for the interest and other costs associated with the Bridge Finance and any consequent impact on carried interest. 

The net IRR calculated as if no Fund Leverage had been available, with Capital Calls from LPs replacing the Capital Calls from the Fund Leverage facility and adjustments made to remove interest and other costs and any consequent impact on carried interest.

c. Fund Modified IRR (MIRR)

MIRR modifies the traditional IRR approach in that it no longer assumes cash flows are re-invested at the same rate. This methodology allows the user to input their own, implied re-investment rate. Whilst this may resolve some of the known flaws of the traditional approach relating to multiple cash flows on various dates both into and out of a fund, it requires the user to input a re-investment rate appropriate to their circumstances. Such re-investment rates are likely to vary according to the individual circumstances of each investor and require detailed knowledge of that investor’s individual circumstances and opportunities for re-investment. Accordingly, it is not recommended as a metric for reporting by a GP generally to its investors.

Use of MIRR should be restricted to situations where an LP has (i) the information to calculate their own re-investment rate and (ii) the detail of the underlying cash flows for each of the funds in which they have invested and which they wish to compare. In such circumstance, it provides an alternative methodology for comparing the performance of those funds.

Where a Modified IRR is calculated, the implied re-investment rate should always be disclosed alongside the MIRR. MIRRs should only be compared to other MIRRs calculated using the same re-investment rate. Comparison of MIRRs with traditional IRRs is never appropriate.

d. Net Multiples on Fund level

Additional frequently used measures of net performance are the multiples to investors of, at the fund level:

• Distributions to paid-in capital (DPI);
• Residual value to paid-in capital (RVPI);
• Total value to paid-in capital (TVPI).

d.1 Distributions to paid-in capital (DPI)

DPI measures on a net basis the cumulative realised proceeds returned by a fund to its investors relative to its paid-in capital (i.e., committed capital that has been called by the fund (contributed capital), not the total committed capital). The metric represents the realised proceeds earned to date by the investors. It does not consider the holding period of the investment or realised proceeds that have already been distributed.

d.2 Residual value to paid-in capital (RVPI)

RVPI measures on a net basis the current fair value (unrealised plus cost) of all assets held by the fund to its paid-in capital (i.e., committed capital that has been called by the fund (contributed capital), not the total committed capital). This metric typically changes at every reporting period owing to changes in fair value of the underlying investments. However, the ratio becomes lower as investments are realised and ultimately goes to zero at the end of a fund’s life. While RVPI provides a measure on unrealised risk, it does not consider the holding period of the investment or realised proceeds that have already been distributed. RVPI should be used in conjunction with other metrics.

d.3 Total value to paid-in capital (TVPI)

TVPI measures on a net basis the cumulative realised proceeds returned by a fund to its investors plus the current fair value (unrealised plus cost) of all assets held by the fund to its paid-in capital (i.e., committed capital that has been called by the fund (contributed capital), not the total committed capital). TVPI = DPI + RVPI. Similar to Net IRR, TVPI at the fund level should be disclosed on a net of fees and carry basis. 

Invest Europe recommends the IRR and the multiples mentioned above as being the most appropriate and commonly used performance indicators at the fund level.

Where GP capital which does not pay carried interest or fees is a small percentage of the fund, it can be included in the net performance calculations, but where it is a significant percentage, it should be excluded, and the resulting net performance figures footnoted to make it clear that GP capital has been excluded from the calculations.

In addition to providing fund level performance metrics noted above, it is standard to report performance metrics at the portfolio (investment) level. These performance metrics can be applied at both the realised and unrealised level and can be shown individually or in the aggregate. Management fees and fund level expenses are not included in these calculations, it only includes capital that was utilized to fund investment purchases. The metrics are a specific indicator of portfolio (investment) level performance. The most commonly used portfolio (investment) level performance metrics are indicated below:

a. Fund Gross IRR

Gross Internal Rate of Return measures the performance of the fund from its investments, and takes account of:

• All the cash outflows (investments) and inflows (divestments, including realisation values, interest and dividends, repayments of principal of loans, etc.) which take place between the fund and all of its investments, independently, whether realised or not;
• The valuation of the unrealised portfolio. By definition, the unrealised portfolio excludes cash and other assets or liabilities held by the fund.

This return does not include the impact of carried interest or charges of any kind, such as management fees paid to the GP by the fund, fees paid or due to lawyers, accountants, fund administrators and other advisers/service providers to the fund (except where such fees specifically relate to a particular investment).

In most cases, Fund Gross IRR equals or is equivalent to Gross Portfolio IRR.

b. Multiple on Invested Capital (MOIC) at (single) portfolio investment level

MOIC is a gross metric that tells an investor how the value of an individual investment in the portfolio has grown expressed as a multiple of the capital that was invested into the individual portfolio investment. MOIC can be expressed as a multiple of realised, unrealised or total proceeds that have been or are still expected to be received from a single portfolio investment.

It is a simplistic calculation and tells investors how much money you are ultimately receiving from an investment, without considering the time value of money, and can be used for realised or unrealised investments.

b.1 Realised MOIC at portfolio (investment) level

Realised MOIC measures cumulative realised proceeds that were already returned by the individual portfolio investment to the fund relative to the capital that was deployed by the fund into the portfolio investment(s) until the reporting date. The metric represents the realised proceeds earned to date by the portfolio investment(s). It does not consider the holding period of the investment nor any future proceeds that the GP is still expecting to receive from the investment. Realised MOIC is also referred to as gross DPI at the portfolio (investment) level.

b.2 Unrealised MOIC at portfolio (investment) level

Unrealised MOIC measures current fair value (unrealised plus cost) of an individual investment held by the fund to the capital that has been deployed by the fund into (a) portfolio investment(s). It does therefore not take into account any proceeds already realised and focusses on future expected proceeds. Similar to RVPI at the fund level, this metric typically changes at every reporting period due to changes in fair value of the underlying investments.  However, the ratio becomes lower as the investment(s) are realised and ultimately goes to zero at the end of a portfolio investment’s life. Unrealised MOIC is also referred to as gross RVPI at the portfolio (investment) level.

b.3 Total MOIC at portfolio (investment) level

Total MOIC measures the cumulative realised proceeds returned by the individual portfolio investment(s) to the fund plus the current fair value (unrealised plus cost) of (an) investment(s) held by the fund to its capital that has been deployed by the fund into (a) portfolio investment(s). Total MOIC therefore equals Realised MOIC + Unrealised MOIC. Total MOIC is shown gross of all fees and expenses and is also referred to as gross TVPI at the portfolio (investment) level.

Public Market Equivalent is a methodology designed to compare performance of a fund against a public market benchmark. To do so, the historic cash flows into and out of the fund are mirrored by equivalent amounts invested into a public market index. Accordingly, Capital Calls into the fund are matched with investments into the public market on the same date and distributions from the fund are matched with distributions from the public markets on the same date, based on the valuation of the index at that date. Finally, a comparison is made at the reporting date between the value that is left in the fund versus the value remaining in the public market equivalent.

In order to be a valid comparator such an index should be one based on re-investment of dividends.

The fundamental challenge for a PME is finding an appropriate public index whose risk/return characteristics are relevant to the fund’s investment strategy, as well as selecting the appropriate currency. This is a subjective area and accordingly Invest Europe does not require reporting of PME or PME+ measures¹_. Where they are reported, details on the public index used should also be disclosed.

1. For PME and PME+ methodology descriptions, please consult the Benchmarking Public & Private Markets with the Public Market Equivalent (PME) report.

a. Commitments made by a fund to a Portfolio Investment

The cash outflows should be taken to be the amount actually invested in a Portfolio Investment at a given point in time, i.e., on a gross return basis. A fund may commit itself to making a series of investments in a Portfolio Investment over an extended period of time. In such circumstances, the timing and amounts of only the individual past cash flows should be taken into account.

b. Equity received in lieu of cash

Any equity received by a fund in lieu of cash in respect of services rendered to a Portfolio Company (for instance, services of directors, provision of guarantees) should be recognised at the Fair Value of the consideration received.

c. Commitments made by an investor to a fund

An LP will commit itself to making a series of investments in a fund over a period of time, up to their committed capital. The cash flows from investors should be taken to be the amount actually drawn down or called by a fund at given points in time. In such circumstances, the timing and amounts of only the individual past cash flows should be taken into account.

d. Net return to investors; carried interest and the unrealised portfolio

When calculating the net return to the investor, as regards the valuation of the unrealised portfolio, appropriate provision should be made for the deduction of carried interest calculated on the basis of the assets being realised at the carrying value.

e. Realisations

Distributions in-specie (in-kind)

Depending upon the provisions of the fund formation documents, shares in companies/assets which are listed and distributed in-kind should be treated as set out by the fund formation documents as to when they are treated as realised.

Other exits

As regards the calculation of the gross return on realised investments only, a written-off investment should be considered as having been realised as soon as the earliest of any of the following or like events takes place: when bankruptcy proceedings are instigated against a Portfolio Company/asset; when a Portfolio Company ceases to trade; when a Portfolio Company enters into arrangements with creditors which result in the investment being written down to zero; or when insolvency proceedings are begun.

Treatment of realisations with deferred consideration

Investments which have been completely sold, subject to a proportion of deferred consideration/earn-out, should be defined as realised investments. An estimate of the fair value of deferred proceeds or earn-out should be included at the reporting date.

f. Taxation

Interest payments, dividends and capital gains received from portfolio companies that are paid net of tax withholdings should be grossed up so as to be treated as pre-tax cash flows for the measure of gross return. Withholding tax which would not be recoverable by a typical tax-exempt investor should be excluded from such grossing up.

g. Timing of cash flows

IRRs are recommended to be calculated on the basis of daily or monthly cash flows. Daily cash flows should use the exact value date of the cash flow. When calculated on a monthly basis, the date attributed to each cash flow should be the same day of each month (e.g., the last day of the month).