Calculating Private Equity Returns with Dated Cash Flows and Terminal Value
Summary
The note describes calculating the annualized return of a private equity investment using its dated contributions, distributions, and a remaining valuation. It explains that the cited GIPS treatment for private equity uses internal rate of return, unlike the time-weighted return generally used for many stock and bond portfolios. The calculation includes each contribution as an outflow, distributions as inflows, and the latest available portfolio valuation as a terminal inflow.
The example reports an annualized return of 7.156% from an XIRR calculation using the supplied dates and amounts. For a year-end report, it recommends using the latest valuation when no December 31 figure is available and clearly identifying its valuation date; a later year-end valuation should be used if available. The response explicitly disclaims expertise in the full GIPS rules, so its brief description should not be treated as comprehensive guidance on GIPS compliance. The reported return also depends on the provided cash flows and valuation.
Key ideas
- Private equity performance in the cited GIPS context is reported using internal rate of return.
- The IRR calculation uses the dates and amounts of contributions and distributions.
- An unrealized investment requires a terminal value in the cash-flow calculation.
- When a year-end valuation is unavailable, the latest available value can be reported with its date identified.
- The note's GIPS discussion is limited and does not cover the full standard.
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Full text
# How to calculate performance of a private equity investment? # How to calculate performance of a private equity investment? Say an investment fund puts \$1 million into private equity investment in 3 installments (\$500k, \$250k, \$250k). You're given a data table which shows the date, contributions (\$500k, \$250k, \$250k in 2016), distributions (which were in 2017), and valuations. (1) How would one calculate the performance of this investment (GIPS standard taken into account)? (2) And how would you value this investment for end of the year 2017? ## Answer by Alex C (score 3) https://quant.stackexchange.com/a/49318 I am not an expert on GIPS, with its many pages of rules, but I do remember that under GIPS Private Equity results are to be given in terms of IRR (Internal Rate of Return). In most other cases (stock/bond portfolios for example) GIPS requires TWR (Time Weighted Return) and forbids the use of IRR. To compute the IRR we need the dates and amounts of cash inflows and outflows (first 3 columns in your table). In addition because this investment has not been liquidated yet we will use the last valuation (527,455 on 2017/09/30) as the Terminal Value in the calculation. We would enter the following in an Excel spreadsheet: ``` 03/15/2016 -500,000 07/10/2016 -250,000 10/25/2016 -250,000 02/20/2017 115,000 05/27/2017 375,000 08/10/2017 63,000 09/30/2017 527,455 ``` Using the =XIRR(B1:B7,A1:A7) function we find: ``` XIRR= 7.156% ``` So the rate of return on this investment is 7.156% per year. As to the second question "the valuation for the end of the year 2017", I would use 527,455, perhaps with a footnote saying this is the value on 9/30/2017, the latest value available. Of course I would use the 12/31/2017 value if it was given.
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