Private equity is doing poorly – however you measure it

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Performance appraisal is an imperfect science: each metric has its pros and cons. Moving the goalposts, however, is rarely a sign that the game is going well. Look no further than the private equity industry, where DPI is the new IRR.

First, the shift in focus from distributions to paid-in capital over internal rates of return is astounding given how poorly the industry does at both.

Private equity’s annualized IRR has fallen below 10% in the year to March 2024, PitchBook says. This is well below the 25% level that the industry used to hold, and even below a rough benchmark for the cost of equity capital. Over the same — admittedly astonishing — period, an unlevered investment in the S&P 500 would have returned 30 percent.

But IPRs look terrible too. Funds from 2019 to 2022 have paid about 15 cents on the dollar so far, according to a Goldman Sachs analysis of Preqin numbers. At this stage of the game, previous harvests had returned well over half of the money invested.

However, there is a difference between the two measures. For a well-bought and well-managed portfolio, IPRs will recover over time. The heady days of portfolio IRRs over 20% are gone for good.

Both measures of performance are affected by the temporary freeze on private equity outflows. IPO markets that close at the slightest fanfare and shy corporate buyers mean it’s difficult to sell portfolio companies. That leaves little money available for distributions. Locked-in companies that don’t skyrocket in value dilute IRRs. Poor performance and lack of returns hurt fundraising, especially for smaller, less diversified funds.

At some point, of course, there will be a thaw. When this happens, IPRs will improve. To the extent that the private equity issues stem from timing (rather than the quality of the assets or the price at which they were acquired), the ultimate fund IPR may not be far from historical average levels of 1.5x.

IRRs – which are highly time dependent – ​​do not offer the same leniency. Back-end loaded cash flows irrevocably harm end-of-fund returns. In addition, the industry model has evolved from fix-and-turnaround strategies to longer-term roll-ups and industrial transformations. Skyrocketing growth rates are difficult to sustain over longer periods, putting industry IRRs under inevitable pressure.

Investors – increasingly desperate to see cash back – are themselves more focused on DPI, rightly so given that cash in hand is worth more than an unrealized IRR in the bush. To the extent that this increases pressure on private equity funds to capitulate, slashing price tags to get assets out the door, it will hurt longer-term performance – regardless of the measure used to measure it.

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