A little commentary from Private Equity International senior editor Toby Mitchenall this morning, entitled, “What does PE really return?” A lot has been written in recent years, including in Private Funds CFO and PEI, about the controversial and confusing nature of internal rate of return (even more so with the increased use of subscription credit lines), and here, Toby argues that some sort of standardized, objective measurement would be good for the industry, staving off misunderstandings or incomplete arguments that you, perhaps not infrequently, see even in the financial press.
You might go a step further, perhaps, and say that providing such a mechanism could be a necessary part of the overall public makeover the industry will need should it produce only a handful more sufficiently negative headlines.
Right now, the best defender of the industry (as we saw during the November House hearings) is its own investors. One would hope, and think, most measure their investments with more tools than just IRR: total value to be paid in, fundamental analysis of portfolio company earnings, etc. While the ILPA has registered some concern about the impact of credit lines on IRR, for example, I suspect many LPs (who themselves use and may be measured in IRR), don’t really care. J-curve mitigation, right?
On the other hand, should IRRs become a more public debate – if for example, there were to be examples of high reported IRRs in funds that performed notably poorly, or even lost money – you could imagine LPs not necessarily going out of their way to defend the way the industry measures its returns, or even its returns at all, without getting something … um … in return … By which I mean plenty of them might, when asked in a public forum by a leading political figure, say something along the lines of “Yes, private equity is usually great for us, but it would be better if we had more control of transparency on [something you’d prefer they didn’t: like, maybe, fees].” Which is also something we saw in the House hearings. (I’m not suggesting anyone here is overcharging their investors; but it’s fairly clear from the temperature of general discussion that there is a buy/sell side schism as to what, and how that what, needs to be disclosed.)
My feeling is, if IRR really is a lasting bone of contention, then it’s only a matter of time before hands are forced. I’m 100 percent for telling investors they need to do their own homework, but do they have access to the tools they need to do it? Is it practical? Basically: who needs to pay to make it clear what investments return? Is the issue all the more pressing as it becomes increasingly questionable that PE is outperforming stocks (here’s a rejoinder to Bain & Co’s recent report, from Wellershoff & Partners Cyril Demaria). Or is the real question whether, at the end of this cycle, PE will again take the stairs down while stocks take the elevator?
I don’t know. Care to tell me what you think? I’m no analyst, but I’d have thought that if Homer Simpson can figure out the mass of the Higgs Boson particle 14 years before CERN, then private equity should be able to figure this one out … does it need to, though?
Email prepared by Graham Bippart