Why is an IRR of 40% bad if investment period is small?
Can someone explain to me why exactly an IRR of 40% across a short time horizon is bad? Let's say i invest 100K today and two years out, I exit and get a cash inflow of 200K. That gets me an IRR of ~41.4%. Seems to me like a pretty sweet deal, but according to the below thread,
https://www.wallstreetoasis.com/forums/moic-vs-ir…
"a 40% IRR across a 3-month investment is useless. You want a dollar value of proceeds that is meaningful to both you and the LPs."
Am I not also doubling my investment and earning a 100K return? Very confused by what this is referencing
I don't work in PE but over a 3 month period, an IRR of 40% is like a 9% return.. If an LP gave you you 100k on 1/1/20 and then you gave them back 109k (less fees!) on 4/1/2020 they probably wont be mad with the 40% IRR, but they almost certainly expected you to deliver more CASH to them so they can pay their pensioners or whatever. You cant pay your bills with IRR alone
Now over 2 years, its probably a different story but the same general idea probably applies.
Yeah that sounds about right! Absolute value returns vs. percentage returns
https://www.oaktreecapital.com/docs/default-source/memos/2006-07-12-you…</a">You Can't Eat IRR - One of the most enlightening memos by Howard Marks on this topic.
Was just about to post this exact link. IRR doesn't mean anything unless it's sustained and compounded over a long period of time.
Agreed, Howard does a great job of speaking further on this topic.
Very helpful
Open excel and put it January 1st 2020 and put in negative 100USD and on January 2nd you get 101USD back.
Use the XIRR formula and you will get the point
Play around with the money back date and you will get a feel of it.
For a HF that’s attractive, for PE funds that need to invest over 5 years its bad.
Even then, if you're a HF you need to then find another opp to deploy that capital, otherwise that cash drag is going to kill returns.
Because your equity multiple can be low. LPs are usually looking for a nice balance between IRR and equity multiple.
Think about expected investment time horizon and opportunity (and time) to place that cash in another return vehicle.
Total depends on the fund. Some fund structures allow the reinvestment or realized gains and in that case an exit line the one you mention isn’t bad, but otherwise a lot funds are looking for at least a 3x MOIC
More meaningful to look at diff. metrics to judge performance - IRR, MOIC should go hand in hand. The link to Howard Mark's article (see above comment) offers a deeper perspective into this and in greater detail.
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