How to measure the investment performance of a private market fund

While the investment performance of public market funds offers clear performance indicators backed by frequent liquidity and transparent reporting, the performance of private market funds is typically more nuanced. 

Within private markets, performance indicators must account for the unique timeline of value creation in private companies, the fundamental differences of an illiquid environment, and the sparse availability of updated valuations and performance information. 

In this article, we’ll discuss the lifecycle of value creation among private companies, how investment funds report on valuations, and why certain performance metrics are used over others.

The lifecycle of private fund performance 

Publicly traded stocks are traded and valued throughout the day; however, the same isn’t true for private companies. 

A private company's maturation may take years to bear fruit, as it takes time to find product-market fit, grow its customer base, and increase revenue. Company valuations are only updated occasionally through new fundraising rounds, secondary sales, or exit opportunities like an acquisition or initial public offering (IPO). 

This timeline of financial performance across private companies is, therefore, reflected in the investment performance lifecycle of private funds. 

We call this phenomenon the “J curve,” which shows that a private fund's performance in the early days is often negative as capital is called from investors and invested into a fund’s first portfolio companies. During the first few years of a fund’s early investments, management fees are being charged by the fund without seeing any valuation increases. 

Only over time, once companies begin to see company valuation changes, does the slope of a fund’s J-curve turn positive. In private markets, most realized investment gains occur during the fund’s harvesting period, which occurs in years 7-10 and beyond. 

Key performance metrics of private funds

Internal rate of return (IRR): IRR measures an investment’s annualized return and considers the timing and magnitude of unrealized valuation markups (“Unrealized IRR”) or cash flows (“Realized IRR”). 

IRR can be reported as gross IRR—the investment’s return before management fees, fund expenses, and carried interest are deducted—or net IRR—the return after all fees, expenses, and carried interest are deducted. Net IRR is what investors actually receive from their investment and is therefore considered a better picture of their investment return than gross IRR. 

Multiple on invested capital (MOIC): MOIC is a simple calculation that reflects a portfolio's unrealized and realized gains as a multiple of your initial investment. Importantly, MOIC is a multiple of your total investment, not just the capital that has been called. 

This figure is expressed using a number followed by “x” to indicate how many times the current value is compared to your initial investment. MOIC is measured on an absolute basis rather than time-weighted, like IRR. 

Total value to paid-in capital (TVPI): TVPI is a calculation similar to MOIC that measures a portfolio's total (unrealized plus realized) gains, with one key distinction. 

Rather than being a multiple of the total invested capital, TVPI is a multiple of paid-in capital—which is the amount of capital an investor has contributed or has been called by the manager at any given time. While capital is being called, TVPI is greater than MOIC. However, once all capital has been called, the “paid-in” amount matches the amount of total invested capital, making TVPI and MOIC identical on a gross or net basis. 

Distributions to paid-in capital (DPI): DPI is often used in conjunction with its TVPI counterpart. However, rather than measuring the total gains in a portfolio, DPI only considers investor distributions. 

DPI is measured as a multiple of paid-in capital, which, like TVPI, increases over time as the fund calls investor capital.

When each performance metric is used

Each performance metric considers different variables in its equation and has different use cases for when it’s the most relevant.

Given its time-weighted nature, IRR is most commonly used in traditional private equity and late-stage venture capital deals. Funds in this market segment seek investor returns within a shorter time horizon and use IRR to compare both the size and timing of returns. 

Performance metrics like MOIC, TVPI, and DPI are more often seen in early-stage venture capital funds as these ignore the impact of the timing of returns and instead focus on the magnitude of returns. Earlier-stage funds can have long holding time horizons. Therefore, they seek larger absolute multiples on their initial invested capital or paid-in capital. 

For some investors, DPI is favored as it measures true investor distributions rather than unrealized markups. Historically, exuberant market conditions have resulted in large unrealized markups but failed to deliver investor distributions, ultimately leaving investors with no realized gains. As a result, DPI has grown in popularity among investors who seek to understand their take-home returns. 

Regardless of the specific asset class a fund invests in, most funds report several of these metrics when presenting their investment performance. Investors can review the different metrics and draw their own conclusions regarding the fund's strengths and weaknesses. 

Comparing your investment performance 

Investment performance can be categorized by distinct vintage years—the year the fund started making investments—as well as fund size, geography, asset class, and industry. These are common differentiating factors between funds, as each of these characteristics impacts the opportunities and challenges a fund manager faces in investing capital. 

Over time, macroeconomic conditions, including inflation, interest rate changes, and geopolitical risks, can also impact fund performance.

Lastly, even different funds managed by the same fund manager can vary dramatically given economic conditions, the availability of attractive investment opportunities, and their selection of certain investment opportunities. 

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