https://www.institutionalinvestor.com/article/b1h…
The article starts off with what I would consider mostly valid critiques of the metric, but only when used alone. IRR in combination with equity multiple, average cash on cash, etc., solves all the issues mentioned, right? Am I missing something?
"The accuracy of IRR has been called into question thanks to the increasing ubiquity of subscription lines of credit. These loans, also known as commitment facilities, have long been used in the private capital industry to finance transactions before investor capital is called in, easing limited partners’ liquidity needs and making it possible for general partners to jump on deals more quickly. But lately, fund managers have been using subscription credit lines differently — and with greater frequency."
The article goes on to say that toying with cash flow timing impacts the IRR artificially. I would argue that 1. if your money could be used elsewhere while the line of credit is in place, that's the correct way to look at returns, and 2. a line of credit that delays contributions won't impact equity multiple, so used together it can't be manipulated in this way.
Disagreed, but fine up until this point. The part that really gets me is this though: " 'If people just quit using IRR, I personally would not be upset,” Albertus says. “And investors would probably be better off.' " ... what??
Anyone have any other thoughts? I would love to discuss. I work in PERE, perhaps there are traditional PE perspectives that I'm not considering here.
EDIT: I know this type of argument isn't new, it's just seemingly popping up again recently.
LPs don’t want GPs hiding shit performance by utilizing sublines, that’s it. No one has issues with KKR or BX using sublines, because they outperform regardless
So maybe it's not the traditional PE perspective I'm not considering, but rather the non-professional perspective. An LP who hasn't worked in the industry is more likely to be "duped" by playing with IRR and cash flow timing/sublines. Would you say that's accurate?
I still think IRR is perhaps the most valuable metric to evaluate, it just needs to be evaluated simultaneously with others like EM and cash on cash.
I’m not a LP PM so a lot of what I say below could be off the mark and I’m happy to be corrected, particularly if someone is knowledgeable about how they manage $ committed to drawdown funds.
I think the IRR a lot of funds put out is in reality a bullshit metric from the LPs perspective, what matters is money multiple. When a LP commits $XM to a closed end drawdown fund they need to me able to fund that commitment in small contributions over several years at relatively short notice (10 BDs). To do so, they need to have cash sitting there or more realistically invested in liquid securities which they can sell to fund capital calls. So while a fund might have a great IRR, if it’s investments are relatively short lives (say 3 year flips and capital sitting in the fund a few months before being reinvested for another 3 year flip) the multiple won’t be great. The fund IRR looks good, but when you work back to the LPs IRR from the point that they committed the capital and had to keep it tied up in low yielding liquid securities to meet capital calls it looks a lot worse.
If a fund uses a capital call / subscription line to further juice IRR by delaying investor capital calls, it might lift fund IRR by 100bps but does this really make a difference to me as an LP if my money is tied up in low yielding securities to meet the capital calls which will be funded a few months later after incurring additional interest cost? No. In reality what it is doing is benefitting the GP by providing additional headroom for the fund IRR over the preferred return they need to beat to get their carry.
But back to your point OP looking at any metric in isolation doesn’t make sense, a high IRR could be a shit multiple, while a low teens IRR could be a big multiple over a long hold. Without having both to sense check off each other, you can’t tell whether the fund performed well.
You can’t eat IRR
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