Writing about private markets - from the LP seat | Helping LPs navigate private markets with clarity
The PME (public market equivalent) method sucks: Grab your coffee, let's look at the chart. We'll compare the performance of a closed-end fund (BLUE LINE) and a public ETF. Our hypothetical fund deployed $50 on date A and returned $95 to the investor on date B. 🎉 The fund generated a 90% return over the period, while the ETF yielded only a 67% return during the same time frame. The closed-end fund has clearly outperformed, right?? Well, no so fast, grasshopper 🦗 What this doesn't capture is some point C that happened some time BEFORE A, when an investor committed $100 to the closed-end fund (remember, the fund only deployed $50 of the committed capital at point A) In today's post, Hanoch Frankovits explains why the PME is not really an apples-to-apples comparison. He'll also tell you how evergreen vehicles will kill this method. 👉 The post is not paywalled - because you need to really understand this if you invest in private markets https://lnkd.in/gaEW2aZc
You said “called $50 on date A” then go on to say “deployed $50” at point A. So the fund called and deployed on the same date? Just want to make sure I follow since calling and deploying capital are two very different actions that don’t necessarily occur on the same day, which does impact return.
A PME from the investor’s point of view can only really be done by the investor, as the manager doesn’t know the return to apply to the committed but not drawn amounts for each of the fund’s investors. Watch out too for not using an appropriate public market comparator as the private fund may take considerably more risk than the public market comparator used in these calculations. Same is true for direct alpha, which does not calculate an alpha at all but an excess IRR and typically excludes the undrawn amounts in the calculation as well. Luckily retail investors understand all of this and are ideally placed to evaluate and invest in private markets.
Victor Hong
3w
One must look at not only debt leverage in private funds. A fair comparison versus public funds must consider committed but undrawn capital, which is not only held idle but also is often subject to returns-dragging AUM fees meanwhile. It is similar to how IRR on invested capital ignores no investment return on committed but undrawn capital.
Managing Investment Officer, MOSERS
3wPut in a different way: Unless an investor maintains market beta exposure during the entire period, including uncalled capital during what is labeled point A and B, most private investment portfolios would underperform relative to simply holding passive market beta. Yes, PMEs illustrate how deployed capital has fared versus an opportunity cost, but if you are forced to remain in ~cash or a lower-returning liquid asset while waiting, that drag might far outweigh any 'alpha' that private markets may generate. We can see this clearly in one of the dashboards we use to evaluate closed-end funds, where we focus on the Excess Value method to determine whether the fund is actually generating 'alpha' in $'s. The issue you are highlighting becomes especially apparent when you compare the dollar return from passive beta with the return generated during periods when capital was actively invested. Unless an investor removes the cash drag element (which can be done in various ways), I suspect most private market portfolios will underperform, even if the majority of their private managers are 'outperforming' from a PME perspective.