Anyone willing to provide some insight on the article below? If this tactic is readily utilized by GPs, it seems like LPs should demand that reported fund returns include the effects/opportunity cost of committed capital...?
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I'm glad someone commented on this, since I saw this article and immediately thought, "this is absurd". In my 10+ years of PE I have never heard of a GP measuring performance on a committed basis. No LP sets aside the full commitment size and holds that $$ amount in cash. A well diversified portfolio will constantly have cash coming in and out, you take distributions from other funds and use it to fund capital calls for new funds. Keeping the full commitment set aside is ridiculously inefficient - most funds can only call up to 25% of commitments per year anyway. How you effectively manage your cash is your job as an LP, not the GP's job - they want to get cash back to you as quickly as possible.
You make a lot of great points. Given what you said, is there any point for the GP to state returns which include the (projected) opportunity cost of the committed capital? For example, to increase LP/GP transparency? I pose this question because I wonder if the typical LP, or an LP that is new to private equity, actually knows that the stated IRR isn't what it seems to be (a compounding black box).
No, the opportunity cost of capital is very different across the spectrum of LPs. A family office or HNW will have a lower cost of capital than an institutional Fund of Funds.
To be honest you can't get much more transparent than cash in / cash out. If an LP doesn't know that the IRR is stated on a cash in / cash out basis, then they shouldn't be investing in private equity.
Haha, that makes sense. Thanks for the clarification. My only concern is that all these different methodologies for portraying returns (as there seems to be) makes it seem like it is much more difficult for the LP to determine which funds are actually top quartile...
There is only one methodology for returns, IRR (and to a lesser extent, net TVPI). But when firms portray their track records, there's no messing around. The SEC audits this stuff.
I'm glad this was posted. The finance industry, specifically Wall Street and Private Equity, are the easy targets in the war against the upper class. This is just another example of a journalist with no true, fundamental understanding of the industry that is attempting to garner pageviews by posting a clickbait heavy article with little to no substance. A similar attack on the industry has recently been pushed by the New York Times and many publications are more than willing to attack the industry, specifically the distressed funds, for the legal means with which they purge Pension liabilities in a restructuring process. Very little credence is given to the fact that no one would pay for the pensions if the outstanding liability remained on the balance sheet. Maybe if the pension funds had been more heavily in private equity, they would have remained solvent.
I would have appreciated a comment that committed capital does not equal funding, and that many investors have very good liquidity from which they can fund the capital calls as they roll in. Regardless, this article heavily skews from truth.
Since you referred to the series of NY Times articles on PE, what do you think about the ones that argue against privatizing public services (like ambulances, waterworks, etc.)? The articles mention how PE firms take advantage of "desperate towns" and systems, and in the case of ambulances, don't necessarily have positive operational growth.
Also curious how the media will interpret Trump's plan to bring in private investors for infrastructure improvements...
Seriously. As someone who has worked on the LP side I felt like I was losing brain cells reading that article. Couldn't even finish it.
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