Return on Investment in Private Equity: How to Measure Performance?

According to Cambridge Associates, buyout funds have historically outperformed many equity indices over long periods. However, measuring the performance of a private equity investment is more complex than for a publicly traded investment.

Unlike a stock, whose value is continuously updated on the financial markets, a private equity investment is based on incremental capital calls, distributions spread out over time, and unlisted equity positions whose value changes over the life of the fund.

That is why the private equity industry uses several complementary metrics to measure value creation. IRR, TVPI, DPI, RVPI, and MOIC each answer a different question.

In this article, learn how to calculate and interpret these metrics to better understand the return on investment of a private equity fund.

Why Is Measuring Performance More Complex in Private Equity?

When you invest in a publicly traded stock, performance can be calculated relatively simply: just compare the purchase price to the sale price, taking into account any dividends received.

In private equity, the situation is very different.

Funds are not invested all at once. They are called in gradually by the management company as investment opportunities arise.

In addition, distributions are made on a staggered basis, as the fund completes the sale of companies.

Finally, part of the portfolio may remain invested for several years before being valued and then sold.

These specific characteristics make it impossible to use a simple annual return calculation.

It is precisely for this reason that the private equity industry has developed several complementary indicators.

An investment that evolves over time

A fund's life cycle explains this complexity.

Unlike a listed investment, performance is therefore built up gradually over the life of the fund.

Why are multiple indicators necessary?

Each indicator answers a specific question.

For example:

• The " IRR " answers the question: What annualized return has this fund generated?
• TVPI measures the total value created since the company's inception.
• The DPI indicates how much capital has already been returned to investors.
• The RVPI measures the value still held in the portfolio.
• The MOIC simply indicates how many times the invested capital has been multiplied.

Taken individually, these indicators provide useful information.

Together, they provide a much more comprehensive view of the actual performance of a private equity investment.

How do you calculate the return on investment in private equity?

There is no single formula for measuring the performance of a private equity fund.

The industry uses several indicators, each of which addresses a different issue.

Before going into detail about each calculation method, it is helpful to understand their respective roles.

Each indicator provides different information.

It is their combined interpretation that makes it possible to assess the quality of a private equity fund.

IRR s (IRR): Measuring Annualized Returns

The Internal Rate of Return ( IRR ), known as IRR in English, is probably the best-known metric in private equity.

It measures the annualized return on an investment, taking into account the timing of capital calls and distributions.

In other words, the " IRR " measures not only how much an investment has yielded, but also how quickly that value was created.

Simplified Formula

IRR is the discount rate that makes the sum of incoming and outgoing cash flows equal to zero.

In practice, this calculation is performed using financial software or a spreadsheet.

Example

An investor commits to investing €100,000.

Capital is called in gradually.

A few years later, he received several distributions before the fund was finally liquidated.

The " IRR " takes into account:

• the dates of capital calls;
• distribution dates;
• the amounts actually invested.

Two funds with the same price-to-book ratio may thus have different " IRR " if they make distributions at different rates.

How should the IRR be interpreted IRR

The " IRR " is particularly useful for comparing two funds with different durations.

On the other hand, it has certain limitations.

For example:

• it is sensitive to the flow schedule;
• A quick refund can artificially improve the web IRR ;
• It does not necessarily reflect the total value created.

That is why it should always be interpreted in conjunction with other indicators.

TVPI : Measuring Total Value Created

TVPI (Total Value to Paid-In) measures the total value created by a fund since its inception.

He adds:

• capital already distributed;
• the value of the equity investments remaining in the portfolio.

He then compares this total to the capital actually invested.

Formula

TVPI = (Residual Value + Distributions) / Capital Called

Example

Capital invested:

100 000 €

Dividends already received:

40 000 €

Current value of the portfolio:

90 000 €

TVPI :

(40,000 + 90,000) / 100,000 = 1.30x

The fund therefore generated 1.30 euros in value for every euro invested.

How should the TVPI be interpreted TVPI

The " TVPI " provides a comprehensive overview of value creation.

However, it does not specify:

• how much has already been distributed;
• how much remains invested;
• how quickly this value was created.

It must therefore be supplemented by the DPI, the RVPI, and the IRR.

DPI: Measuring Capital Already Distributed

The DPI (Distributed to Paid-In) indicates the portion of capital that has already been actually distributed to investors.

It measures only cash actually received.

Formula

DPI = Dividends / Paid-in Capital

Example

Capital invested:

100 000 €

Capital Already Distributed:

60 000 €

DPI:

0,60x

In other words:

60% of the invested capital has already been repaid.

How should the DPI be interpreted?

The further along the fund is in its life cycle, the higher the DPI becomes.

Upon the fund's liquidation, the net asset value per share ( TVPI ) and the DPI become identical, since all of the value has been distributed.

RVPI: Measuring the Value Still Invested

The RVPI (Residual Value to Paid-In) measures the value of the equity interests that remain held by the fund.

It therefore represents the potential for value creation that still exists in the portfolio.

Formula

RVPI = Residual Value / Capital Called

Example

Capital invested:

100 000 €

Current value of the portfolio:

80 000 €

RVPI:

0,80x

The portfolio still represents 80% of the initial investment.

How should the RVPI be interpreted?

A high RVPI is common in the early years of a fund, when few companies have been sold.

As distributions increase, the RVPI gradually decreases.

It is therefore always interpreted in conjunction with the DPI.

MOIC: Measuring the Multiple of Invested Capital

The MOIC (Multiple on Invested Capital) simply indicates how many times the invested capital has been multiplied.

This is probably the most intuitive indicator.

Formula

MOIC = Total Value Recovered / Capital Invested

Example

Capital invested:

100 000 €

Amount recovered:

220 000 €

MOIC:

2,2x

Every euro invested generated 2.20 euros.

How should the MOIC be interpreted?

The MOIC is very easy to understand.

However, it does not take the time factor into account.

Two funds with a 2x MOIC can have very different performances if one achieves that result in five years and the other in twelve years.

That is why the web IRR remains essential.

Why a Single Indicator Is Never Enough

One of the most common mistakes is to evaluate a private equity fund based on a single performance metric.

In reality, no single indicator can, on its own, measure the total value created by a fund.

IRR, TVPI, DPI, RVPI, and MOIC each answer a different question. It is only by interpreting them together that one can understand an investment’s true performance.

Each indicator provides specific information

Let's take the example of a fund with a price-to- TVPI of 2.0x.

At first glance, this result seems very satisfactory: for every euro invested, the fund generated two euros in value.

But this information is not enough.

The web TVPI site does not specify:

• how much capital has already been distributed;
• what portion of this amount remains invested;
• how quickly this result was achieved.

To answer these questions, it is necessary to supplement the analysis with other indicators.

Each indicator therefore provides additional insight into the fund's performance.

Example: Two funds may appear to be identical

Let's imagine two funds with a MOIC of 2.0x.

At first glance, they appear to have generated the same performance.

However, their profiles can vary greatly.

Fund A has already distributed most of the value it has created and has achieved this performance over a relatively short period of time.

Fund B still holds a large portion of its value in its portfolio companies. Its potential remains significant, but that value has not yet been realized.

Without analyzing the DPI, the RVPI, and the IRR, these two funds might appear to be equivalent, even though their profiles are very different.

An interpretation tailored to the fund's life cycle

The importance of each indicator also changes over the course of a fund's life.

In the early years, distributions are generally limited.

The RVPI therefore accounts for a significant portion of the total value.

As companies are sold, the DPI gradually increases while the RVPI decreases.

At the end of the fund's life, the TVPI s consist almost entirely of DPI.

This trend explains why institutional investors always analyze indicators within the context of the investment vehicle's life cycle.

An approach favored by institutional investors

Large institutional investors, such as pension funds, insurance companies, and family offices, never rely on a single indicator.

Their analysis typically combines:

• IRR, to assess the annualized return;
• TVPI, to measure overall value creation;
• the DPI, to evaluate the distributions that were actually made;
• the RVPI, to assess the remaining potential;
• the MOIC, to quickly see the resulting price-to-book ratio.

This comprehensive approach provides a much more accurate picture of a private equity fund's performance.

The Most Common Mistakes in Interpreting Performance Data

Even when key indicators are available, interpreting them can lead to erroneous conclusions if they are not viewed within the context of the fund.

There are certain mistakes that investors new to private equity tend to make repeatedly.

Compare only the IRR

IRR is a key indicator, but it should not be analyzed in isolation.

A fund that has quickly distributed a portion of its portfolio may report a high “ IRR ,” without necessarily having created more value than another fund whose distributions will occur later.

Therefore, comparing only the IRR may result in an incomplete understanding of performance.

Confusing potential value with realized value

TVPI includes the value of the holdings still owned by the fund.

This figure is based on periodic valuations and does not represent cash already distributed.

To measure the amounts actually distributed to investors, the DPI remains the benchmark indicator.

Forgetting the fund's life cycle

Comparing a fund in its fourth year with one in its tenth year generally doesn't make sense.

The first stage is often characterized by a high RVPI and a still-limited DPI.

The second company will have already completed a large portion of its divestitures.

Performance analysis must always take the fund's maturity into account.

Neglecting the quality of management companies

The indicators measure past performance or performance that is currently being generated.

They are not a substitute for analyzing investment strategy, the experience of the management teams, portfolio diversification, or investment discipline.

Institutional investors consistently supplement quantitative analysis with a qualitative analysis of the Fund manager.

Why Performance Must Always Be Analyzed in Light of Risks

Performance metrics can be used to assess the value creation of a private equity fund, but they are not sufficient on their own to evaluate all the characteristics of an investment.

Like any asset class, private equity involves risks that should be taken into account in the analysis.

A performance that is part of a long-term strategy

Private equity is based on investments in unlisted companies whose growth can take several years.

Capital is generally tied up for a long period, often between eight and twelve years. Opportunities to exit before the fund matures remain limited and may depend on the existence of a secondary market.

The investment horizon is therefore a key element of the analysis.

Past performance is no guarantee of future results

Metrics such as the IRR, the TVPI , or the MOIC describe a fund's performance at a given point in time or over a past period.

They do not predict the performance of future investments.

Value creation depends, in particular, on:

• the quality of the selected companies;
• the management company's strategy;
• economic conditions;
• valuation levels for investments and disposals.

Past performance should therefore always be viewed with caution.

The Importance of Diversification

Institutional investors generally limit their risk by diversifying:

• the managers;
• investment vintages;
• industries;
• geographic areas;
• Private Equity Strategies.

This approach helps reduce dependence on a single operation or a single economic cycle.

Conclusion

Measuring return on investment in private equity requires a more nuanced approach than that used for publicly traded assets. Investments are made gradually, distributions are spread out over time, and a portion of the value remains invested for several years.

That is why the industry relies on several complementary indicators. The " IRR " measures annualized returns; the " TVPI " measures total value creation; the "DPI" measures actual capital distributed; the "RVPI" measures the value still present in the portfolio; and the "MOIC" measures the capital generation multiple.

Taken together, these indicators provide a much more comprehensive picture of a fund’s performance than a simple annual return. They offer a better understanding of value creation throughout the life cycle of an investment and are now the primary tools used by institutional investors to analyze private equity funds.

Like any investment, private equity carries a risk of capital loss, and past performance is not indicative of future results. The indicators presented in this article are analytical tools and should be interpreted within the context of each investment strategy.