The Faulty Metric at the Center of Private Equity’s Value Proposition

“Manipulated.”

“Inflated.”

这三个字已经越来越多的被用于describe private equity returns — or at least one popular measure of private equity returns: the IRR.

The internal rate of return measures how a portfolio performs on a dollar-weighted basis and includes the effects of cash flows like capital calls and fund distributions. It has long been used as a performance indicator for private capital funds, which have surged in popularity over the past decade as investors have sought to diversify their portfolios in the wake of the financial crisis.

But although it’s been widely used, IRR has never been a perfect representation of private capital returns. Oaktree Capital Management co-founder Howard Marks has been pointing this out since 2006, when he popularized the phrase “You can’t eat IRR” in a client memo arguing against overreliance on the performance metric. Investment consultants have similarly been telling clients for years to examine not just IRR, but investment multiples, underlying portfolio company earnings, and countless other performance indicators.

然而，尽管如此，IRR仍然是私募股权表现所突出的行业最广泛的速记，这是筹款投资手册，并赋予养老基金委员会和捐赠投资委员会作为投资组合如何做的证据。安德烈·奥尔巴赫（Andrea Auerbach）在咨询和投资公司Cambridge Associates领导私人投资，描述了“私人投资者讨论资金的共同语言”的内部回报率。

She explains: “It’s never been a number you should just take by itself, but it’s always been a great signifier of where a manager might stand.”

Over the past two years, however, the accuracy of IRR has been called into question thanks to the increasing ubiquity of subscription lines of credit. These loans, also known as commitment facilities, have long been used in the private capital industry to finance transactions before investor capital is called in, easing limited partners’ liquidity needs and making it possible for general partners to jump on deals more quickly. But lately, fund managers have been using subscription credit lines differently — and with greater frequency.

根据替代数据提供者预票，私募股权基金之间的承诺设施使用more than tripledin the past decade, with 47 percent of funds launched in 2010 and later having utilized the financing tool, compared with 13 percent of funds launched before 2010. And it’s not just that more private fund managers are taking out these loans. Preqin also reported that these once short-term instruments are now being used to delay capital calls longer — which investors, researchers, and other industry experts claim is leading to artificially inflated IRRs.

“This more aggressive use of commitment facilities has really complicated using IRR as a common language,” Auerbach says. “You have to ask more questions.”

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The most obvious question:Are IRRs真的being artificially inflated?

The answer, according to an emerging body of academic research, is yes.

Two recent papers — one from a pair of Carnegie Mellon business school professors, one co-authored by two German researchers with a BlackRock private equity director — have explored the effects of subscription credit lines on IRRs and arrived at the conclusion that the loans have meaningfully improved IRRs without increasing the actual amount of money that investors take home.

The German researchers, Pierre Schillinger and Reiner Braun of the Technical University of Munich, worked with BlackRock Private Equity Partners director Jeroen Cornel to simulate how real buyout funds would perform if they had hypothetically used subscription credit lines. Simulating commitment facility use for less than six months resulted in only a 47-basis-point increase in IRR on average, or a 20bp improvement at the median. But increasing the time frame of the loan to a year led to an average IRR bump of 120 basis points — a median increase of 57bp.

“If used extensively, [subscription credit lines] can indeed lift fund returns substantially,” theyconcluded.

The Carnegie Mellon professors, meanwhile, took the opposite approach, using data provided by private capital analytics firm Burgiss to identify funds that had used subscription credit lines, then calculating how their IRRs would change if the loans hadn’t been used. James Albertus and Matthew Denes, both assistant finance professors at the Tepper School of Business, found that the use of commitment facilities boosted IRRs by 6.1 percentage points while causing a slight dip in the total value to paid-in multiple, or TVPI, due to managers’ paying interest on the loans.

Speaking to亚博赞助欧冠, Albertus and Denes emphasized that thecurrent versionof their paper — “Distorting Private Equity Performance: The Rise of Fund Debt” — is a first draft, and that they plan to conduct further analysis with a larger sample size and a methodology that includes additional performance metrics, like PME, the public market equivalent. But even their early findings make a compelling case that subscription credit lines do, in fact, inflate IRRs.

“It highlights ways that this performance measure could be distorted,” Denes says.

与此同时，像奥尔巴赫这样的投资专业人员正在首先在ARRS首次上目睹订阅信用额度的影响。她注意到，剑桥员工顾问已经遇到了一些录得“不可能”的IRS的普通伙伴，这是“不可能的承诺设施”。

“我听到很多感觉,说这是一个2016 vintage, a three-year-old fund, and I’m like, ‘What’s the performance?’ — and they say, ‘Oh, it’s a 50 percent IRR,’” Auerbach explains. “So then I say, ‘What’s the multiple?’” If the multiple seems low in contrast to the sky-high IRR — say the value generated by the fund is only 1.15 times the amount put in — “I automatically assume there’s a commitment facility,” she says.

根据奥尔巴赫的说法，这些不平衡的性能数字开始越来越多地突破五六年前，以来一直在增强，因为管理者在一个更拥挤的市场中脱颖而出。

“I think once GPs realized that maybe their competitors were using a little extra something-something, then they were like, ‘Well, maybe I need to use mine just a little bit too,’” she says.

General partners, for their part, are pushing back against claims that they are intentionally manipulating IRRs. Jason Mulvihill, chief operating officer and general counsel for private equity lobbying group the American Investment Council, said in a statement toII对夸大的危机令人担忧的是“夸大了并忽视了复杂的投资者通过各种指标评估基金表现的更大背景。”

In fact,一个分析by private capital data provider PitchBook found that IRRs of recent funds did not appear “categorically inflated” when compared with the IRRs of older vintages. The PitchBook analysts examined private equity funds with launch dates ranging from before 2000 to the period between 2012 and 2015, and concluded that the ratio of IRR to TVPI has stayed roughly constant across vintages, despite the increasing use of subscription credit lines.

与此同时，美国投资委员会等一般合作伙伴和支持者继续指出贷款在弥合资本呼叫之间差距的有用性。“他们确保有限合作伙伴可以规划普通资本呼叫，同时仍然允许资金迅速对新交易作出反应，”Mulvihill说。“这为基金和有限合伙人提供了双赢。”

Even if subscription lines of credit happen to boost internal rates of return, an artificially higher IRR is not necessarily going to be seen as negative by all, or even most, limited partners. “LPs are themselves measured in terms of IRR, and they might have their own incentives,” says Brian Gildea, head of investments at alternatives firm Hamilton Lane.

至少,吉尔表明承诺facilities have been helpful in mitigating private equity’s dreaded J-curve — the tendency of funds to have low or negative returns in the early years before investment gains start to be realized. It’s a point echoed by Adrian Sales and Tom Cawkwell, investment consultants at Albourne.

“LPs find it very difficult to say to their board, ‘Ignore the negative IRRs for a couple of years,’” say Cawkwell, who serves as Albourne’s head of private markets. “It’s a lot more comfortable to say that IRRs look good.”

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The real problemwith subscription lines of credit, as Cawkwell and his colleagues see it, is not their impact on IRR. Instead, it’s a lack of understanding of their use — partly due to limited disclosures from general partners.

“They’ve become a market standard,” says Sales, Albourne’s head of operational due diligence. “Our focus is more on educating clients in terms of how managers are using them, and ensuring that both the disclosure and the use of them [are] appropriate.”

Leading the effort to improve manager disclosure of subscription credit facilities is the Institutional Limited Partners Association, a trade group for private equity LPs. ILPA published its firstguidelineson subscription credit lines in the summer of 2017 — a move that arguably helped usher in the current debate on the use of these loans.

The specific proposals from ILPA included recommendations on how to better benchmark manager performance and factor loans into manager hurdle rates. The guidelines also included a mandate that general partners always disclose net IRRs with and without the use of commitment facilities. According to Jennifer Choi, ILPA’s managing director of industry affairs, the limited partner group made the recommendations “knowing there would be some degree of pushback” from general partners.

“从我们认为这一指导的观点取得了最大的成功是，现在发生了不同的谈话，”崔说。“GPS正在更加常见，他们如何使用订阅信用，LPS问更多问题并更加批判。”

自从这些指南出版的这两年后，崔表示，国际劳工组织继续评估应披露贷款的最佳实践及其对IRR的影响。投资者集团旨在旨在在今年年底之前提供进一步的建议。

In the meantime, another industry group, the CFA Institute, has come out with its own recommendations surrounding the impact of subscription credit lines on IRR. The 2020 Global Investment Performance Standards — an updated version of the CFA Institute’s reporting standards that’s meant to be more applicable to alternatives managers — includes a requirement that fund managers report IRRs with and without subscription credit facilities any time a loan is used for longer than 120 days.

今年早些时候发布的2020年GIP的一款版本遗漏了贷款在不到120天内偿还的豁免。“我们采取了非常黑白的视角，”CFA学院全球产业标准负责人Karyn Vincent说。她表示，他们收到了“使用子行以获得非常短期目的的利用，只是为了促进资本呼叫的总署”。他们质疑在没有使用贷款的情况下计算IRR是否真的有意义。Vincent认为，修订的建议将导致私募股权经理更广泛地通过GIPS标准。

For now, however, it remains to be seen whether the GIPS standards or the ILPA recommendations on subscription credit lines will be widely implemented by limited partners or their private equity managers. But even if the level of disclosure and the understanding of subscription credit lines start to improve, IRR’s usefulness as a performance metric has been forever compromised.

“Now you’re having to say to GPs, ‘Give me two IRR numbers, and I want the multiple,’” Cambridge’s Auerbach says. “IRR has been taken away as an acceptable first-cut litmus test of performance.”

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You still can’t eat IRR— but there aren’t exactly any other performance metrics that would be easier to digest.

例如，像TVPI一样的倍数被视为与IRR的互补，但不可用可行的替代品。“这使得难以排队并并排比较性能 - 特别是在其他资产类别上，”汉密尔顿巷的吉难说。“其他资产课程正在衡量年度表现，而IRR是在私人市场中最接近的方式。”

PME, which has recently started to catch on as a better way to compare private asset funds with public market benchmarks, has its own issues. Like IRR, it relies on cash flows — meaning it could also be impacted by loans. “PMEs don’t solve the sub line problem,” Sales says. “I’d say IRRs are certainly here to stay as a way of understanding the portfolio.”

目前，像Albourne这样的咨询公司继续倡导使用多种性能指标 - 并以替代测量性能的方式进行实验。根据销售，吸引客户的一些兴趣的方法涉及“运行整个投资组合的模拟，没有投资。”

与此同时，剑桥建立了投资级基准，追踪底层投资组合公司而不是资金级别的表现。“我们正在用它来刺穿面纱，直接看看潜在的投资自己，”奥尔巴赫说。

尽管如此，像教授和亚伯大学这样的行业观察家正在为IRR替代而努力，最好是一个更难操纵的人。

“如果人们只是用IRR戒烟，我个人不会心烦意乱，”艾伯塔斯说。“而投资者可能会更好。”