A fund benchmark is a performance yardstick: It provides a standard for comparison. In the private markets, benchmarking provides a way for limited partners (LPs) and general partners (GPs), to gauge the performance of individual funds and evaluate broader performance across asset classes. However, unlike in the public markets—which have widely used indexes for different market segments, such as the S&P 500 and Dow Jones Industrial Average—the private markets have no single “standard” measure for assessing a fund against its peers.

The lack of a uniform methodology for constructing venture capital benchmarks and private equity benchmarks has led to inconsistent approaches across the industry and difficulties in deciphering how well individual funds and investment strategies have performed. It also creates an opportunity for constructing more relevant, custom benchmarks to help inform better decision-making.

 

Why custom fund benchmarking matters

Private market funds operate very differently from almost every other investment strategy. They’re closed-end vehicles, so a lot of the traditional public market metrics that people use—whether for broad equities, or a mutual fund or a hedge fund—just aren’t appropriate. Many private capital benchmarks are problematic though, because they are based on basic attributes like vintage year, fund type (PE, VC, etc.), fund size and high-level location—and these slices are often too broad for an adequate comparison.

Despite these shortcomings, LPs and GPs often spend a significant amount of time trying to make generic third-party benchmarks work for the specific comparisons they’re interested in. These premade benchmarks have their purposes, of course—they do give a general sense of how an investment strategy is performing, after all. However, when used to make comparisons between specific funds and fund strategies, they often force LPs and GPs to make less informed investment decisions—a risk that could be mitigated if they had the ability to create custom benchmarks on their own.

Transparency is also an issue. Investors need insight into the underlying data used to construct a benchmark to determine if it is suitable for their purposes or if a more tailored approach is needed for an appropriate comparison. But most third-party benchmarks outside of PitchBook's don’t expose the underlying funds they consist of, the investments those funds have made or even the performance of the component funds.

This lack of transparency can leave important questions unanswered. For example, are the comparison funds investing in the same types of companies? Or even the same industries?

In the end, this means critical details that can be used to better evaluate performance are lost.

What to include in a custom fund benchmark

In addition to the usual information third-party private market benchmarks provide on vintage year, fund type, fund size and location, consider also finding better comparisons by examining:

  • Portfolio construction
  • Investment mandates
  • Industry and/or sector focus
  • Narrower definitions on fund size and location
 

All of these factors can be helpful for creating a more accurate understanding of fund performance—which ultimately leads to better investment decisions.


Want to learn how you can create better custom benchmarks with PitchBook? Reach out to our Customer Success Team or request a free trial

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