Written by Samuel Henly, PitchBook academic in residence, along side PitchBook’s 3Q 2013 PE & VC Benchmarking & Fund Performance Report.
PME metrics benchmark the performance of a fund (or group of funds) against an indexed alternative investment. For example, one could use a PME to compare the performance of a PE fund to the performance of publicly-traded stocks indexed by the Russell 3000 Index. When PMEs are generated for many funds, the PME values can be used to rank fund performance controlling for broader market behavior.
The two most common measures of PE performance, IRR and cash multiples, are adequate measurements of fund performance when used judiciously. However, IRR and cash multiples can’t be directly compared to indices that are used to evaluated performance in mainstream asset classes. The purpose of public-market equivalent benchmarks (PMEs) is to make fund performance directly comparable to the performance of indexed asset classes.
In this brief, I introduce three measures that can be used to compare the performance of private equity to public markets.
PME benchmarks compare the performance of a fund, or a group of funds, with an indexed alternative investment. That is, PMEs compare the performance of funds with an entirely separate class of assets, rather than directly with a group of peer funds. Industry participants might find PME benchmarks useful in comparing a private equity fund’s performance to similar publicly-traded equities; for example, a PME could be used to compare a healthcare-oriented PE fund to publicly-traded healthcare stocks. Going further, PMEs would allow individuals with sufficient data to compare the market-adjusted returns attained by individual funds, generating fund performance quantiles.
The first two PME variants I will discuss rely on the creation of a fictional PME vehicle using the cash flows of a real PE fund. Once this vehicle, representing an index, is created, its IRR can be computed for apples-to-apples comparisons with the PE fund. Unfortunately, PE funds that significantly outperform the PME vehicle will produce nonsensical output under the first method. The second method avoids this problem, at some cost of comparability.
The last PME variant avoids the creation of an intermediate vehicle, and instead generates a cash multiple that discounts PE fund cash flows by indexed market returns.
To read the remainder of PME Benchmarking Methods, download the PDF.