Private-equity investments can be a bit of a black box when it comes to measuring returns. Unlike other asset classes like bonds or publicly traded stocks where it is easy to calculate returns based on purchase price, current price, and time elapsed, private-equity investments are more complex. Capital is set aside for these investments, but it is only “called” once a suitable project is found. This means that there is a lack of information about the value of the investment once it is made. Cash returns are also irregular, making it difficult to track the performance of these investments.
Investors in private-equity funds, known as “limited partners,” are provided with a variety of measures to assess the performance of their investments. These measures include irr (internal rate of return), mom (multiple of money), and many more. Each measure has its own flaws, with some relying on potentially inflated valuations of assets and others not taking into account the cost of capital. However, one measure that is considered reliable is cash distributions as a share of paid-in capital, known as “dpi.” This measure looks at the cash that private-equity firms return to investors each year relative to the amount that the investors have paid in. It is difficult to manipulate and takes into account the fees charged by the funds.
Despite the challenges in measuring the performance of private-equity investments, investors are mainly concerned with the bottom line – how much money they are making. While irr and mom are important metrics, the cash distributions as a share of paid-in capital give a clear picture of how profitable these investments are. This measure helps investors understand the actual returns they are receiving and the impact of fees on their overall profits.
The cash distributions as a share of paid-in capital also highlight the importance of regular and significant returns from private-equity investments. For pension funds and university endowments that invest in these funds, consistent cash flow is crucial for meeting their financial obligations. By tracking dpi, investors can assess whether their private-equity investments are meeting their expectations and providing the necessary returns to support their long-term financial goals.
In conclusion, while measuring the performance of private-equity investments can be complex and challenging, focusing on cash distributions as a share of paid-in capital provides a clear and reliable indicator of profitability. By tracking this metric, investors can gain insight into the actual returns they are receiving from their investments and assess the impact of fees on their overall profits. With this information, investors can make informed decisions about their private-equity investments and ensure they are meeting their financial objectives.
