that reinvestment rates can, and often do, vary. Davidson says,“ If a company is sold within a short period of time and the fund manager can’ t reinvest the proceeds at the original IRR, it will appear as if the investment underperformed. This is why investors rely on other metrics to augment the reported IRR.”
Another flaw with the internal rate of return is its emphasis on early cash flows, even though private equity funds tend to generate negative or small positive returns at the start, followed by higher returns as its portfolio companies mature( a phenomenon called the“ J curve.”) In some cases, such as when an investment has alternating periods of positive and negative cash flows, an analysis results in multiple IRRs. When this happens, decision makers may be confused about which IRR to select.
And some investment opportunities might be incorrectly accepted if the decision maker relies solely on the IRR metric instead of net present value( dollars). This situation can occur when projects differ significantly in scale or the timing of cash flows significantly differs.
Noreen Brown, the co-chief investment officer at Summit Financial, says,“ There are many variables that determine a fund’ s IRR, including the use of credit lines to acquire new positions.”
Other Performance Metrics Matter
Given the inherent limitations of the internal rate of return, it’ s not surprising that experienced investors and their advisors augment their analyses with other quantitative metrics and a variety of insights into the ways private equity funds manage themselves. Tom Bratkovich, chief investment officer at DCA Family Office, says specific transactions will require specific metrics.
“ We might look at income or cash yield, similar to interest on a bond, or prioritize multiples that express the earnings power of how much we invest,” he says. Like other investment practitioners, he acknowledges the imperfections of each indicator, adding,“ IRR tends to distort returns in the short run, but the multiple on invested capital is less useful with long holding periods since it does not reflect the cost of illiquidity to the investor.”
Underlying assumptions can’ t be ignored. With both IRR and the multiple on invested capital, someone must estimate what they hope will be an accurate terminal value. It’ s easier said than done to estimate a distant sales price, particularly in a market roiled by geopolitical events, uneven regulations across industries and countries, and U. S. and international interest rate policies. It’ s why diligent investors ask private equity fund managers about their use of Monte Carlo simulations and the other ways they model their final cash flow.
The unit of measurement is likewise relevant. Zac Murphy, an investment analyst at Ullman Wealth Partners, says his clients focus on dollars, not internal rate of return percentages.“ We think DPI is a helpful metric, especially for long-term asset classes like private equity,” he says.
Indeed, McKinsey & Company performed a survey of limited partners in January 2025 that showed distributions to paid-in capital were a more critical indicator than they were three years ago. In 2025, distributions to limited partners rose above capital contributions to a nearrecord level. That was partly because lower valuations had discouraged sellers, who opted to wait for better conditions. Another report,“ PwC’ s Global Family Office Deals Study 2025,” showed a fluctuating but overall decline in deal value between 2022 and early 2024, followed by an uptick( though the deals had still not returned to pre-pandemic highs).
Investors frequently examine distributions-to-paid capital numbers provided by each fund manager with another metric— the total value to paid-in capital. The goal is to examine more than the liquidity returned to investors by considering potential upside. The total value metric is meant to track a general partner’ s ability to identify new opportunities— or even to take a company public, sell it, or orchestrate a merger with another business. Unlike the IRR, the total value to paid-in capital ratio does not consider the time value of money, reinvestment rates, or the timing of cash flows. It is, however, dependent on a fund manager’ s estimates of residual( unrealized value) that may or may not materialize.
Ask About Valuation Process
Understanding how each private equity fund manager values illiquid assets is a sine qua non of effective due diligence. Valuation policies and procedures guide each fund manager’ s decisions about what to buy, when to sell, when to call capital from the investors, and how much cash to reserve. These same valuation policies and procedures directly influence the performance reports provided to investors, which in turn guide their decisions about whether to allocate monies and, once allocated, remain with a particular private equity fund manager. As Monish Verma,
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