• While in public markets, transparency, real-time data and benchmarks are the key to clear benchmarks allow for direct comparisons, in Private Equity the lack of liquidity, long investment horizons and opacity of assets mean that standard metrics do not always accurately reflect reality.

Recap: Metrics in Public Markets 

In the public markets, the most common measurement tools include total return, Sharpe Ratio and Information Ratio. These metrics allow risk-adjusted performance to be assessed by comparing fund returns to a benchmark index. Liquidity and the availability of daily data make these metrics accurate and useful in real time. However, in the Private EquityHowever, in private equity, the metrics are more complex, and comparisons are not always as direct.

Key Private Equity Metrics  

At Private Equitythe main performance metrics include:

1. Internal Rate of Return (IRR): This is the industry standard metric, which measures the annualized return considering cash flows and time value of money. However, it can be susceptible to manipulation, but more importantly, it is highly sensitive to "timing".timing"and dependence on unrealized valuations make it less reliable in some cases.

1. TVPI(Total Value to Paid-In Capital): This indicator measures the total value of the fund in relation to the capital committed by investors. Unlike the IRR, it does not take into account the time value of money, which is a problem, but it is an easy metric to interpret (as soon as $1 was converted), what should be taken into account is that within the TVPI is the NAV, which is an estimate.

1. DPI(Distributed to Paid-In Capital): Measures what has already been distributed to investors in relation to their committed capital. It provides an accurate picture of realized returns, but does not yet reflect the remaining value in assets not yet sold.

One of the major difficulties with these metrics is that asset valuations are not final until an "exit" occurs.exit"This introduces uncertainty in the calculations and potential distortions. It also makes comparison with other funds more difficult for the same reason.

Common Problems with Metrics in Private Equity.  

Correctly assessing performance in Private Equity faces several obstacles:

1. Long Time Horizons: Unlike public funds, where liquidity is immediate, PE funds are usually tied up for 10 to 15 years. This makes direct comparison between investments with different time horizons difficult.

1. Estimated valuations: Private funds face the challenge of valuing assets that are neither liquid nor have a clear market price. Valuations, when estimated, can distort metrics such as IRR and TVPI.

1. IRR problems: Since IRR is tied to the timing and magnitude of cash flows, it can be susceptible to manipulation. Recently the use of credit lines in funds has been one way to look at this problem.

Comparison with the Public Market: PME  

One of the ways to overcome these problems is the **PME metric (Public Market Equivalent)** metric, which compares the performance of a private equity fund to the performance of a public equity fund. Private Equity with an investment in a public market index under the same cash flow schedules. A PME greater than 1 suggests that the fund has outperformed the public market over the same period. While not immune to all of the above problems, this metric provides greater clarity in the comparison between private and public funds.

Improvement Initiatives: General Partners Rankings

Faced with the limitations of traditional metrics, initiatives have emerged that seek to improve transparency and comparability between PE funds, most notably the approach based on the ranking of General Partners (GPs). One of the most notable efforts in this area has been developed by Professor Oliver Gottschalg of HEC Paris.

Gottschalg's methodology ranks GPs not only according to metrics such as IRR or TVPI, but adjusts these calculations to account for variables such as vintage year and other external factors that can distort reported performance. This approach allows for a more accurate view of GPs' ability to generate value by comparing their performance across different economic cycles and strategies.

By offering a tighter view that is less prone to distortions, these rankings help investors select funds with a higher probability of sustained success over time, based on the proven quality of the manager rather than on results inflated by one-off circumstances or number manipulation techniques.

Conclusion 

Evaluating performance in Private Equity remains a major challenge due to the lack of liquidity and transparency in asset valuation. While traditional metrics such as IRR, TVPI and IPR are useful, they can be misleading if their limitations and the circumstances that can influence them are not taken into account. None of these metrics are perfect, so they must be complemented by broader considerations. In private markets, one is essentially signing a "blank check" by investing in a "blind pool"This means that in addition to quantitative metrics, it is essential to evaluate qualitative factors, such as the General Partner's (GP) experience, approach and ability to execute. These aspects are not always reflected in the track recordbut they are essential for a complete evaluation.

The WEP provides a partial solution by allowing a direct comparison with public markets, while initiatives such as the General Partners rankings adjusted for external variables offer a more sophisticated approach to choosing funds and assessing GPs' capacity. Ultimately, investors must look beyond conventional metrics and adopt approaches that better capture real value creation in private markets.

Alexandra Budge : CFA Society Chile