Which Private Equity Benchmarks Should Your Firm Adopt?

Compared to measuring public market investments, benchmarks for private equity funds are a whole a different ball of wax. As a relatively new asset class with irregular cash flows, private equity requires a different way of thinking than other asset classes.

Over the past decade, Limited Partners (LPs) have been using public market-equivalent (PME) benchmarks to measure fund performance. While PMEs are more complex to calculate, they do offer methodological benefits. Still, many firms prefer to use their own measurement techniques, often based on comparing Internal Rate of Returns (IRRs) to stock indexes.

Private Equity Benchmarks

 

For any investment firm, however, a good benchmark should be applicable, understandable, and reflective of the underlying portfolio. A critical part of managing risk, benchmarks help firms evaluate past investments, understand the overall picture, and ultimately, make informed decisions. To help you stay relevant—and stay ahead of your competitors—we’re covering the basics your firm can use to develop powerful performance benchmarks that will help you attract investors.

Crucial Components of Private Equity Benchmarks

 

Understanding private equity performance can be complex. While benchmarks should reflect the fundamental characteristics a firm believes will make a good investment, the types of benchmarks often vary from LP to LP. As a result, LPs can use their benchmark choices to differentiate their firm from competitors.

Of course, before deciding whether or not to invest, firms need to carefully understand what they’re measuring against with their chosen benchmarks and need to know:

  • Is the investment liquid or illiquid, private or other asset?
  • What’s the performance over time?
  • What’s the opportunity cost of investments?

Generally driven by mandates like non-U.S. funds under $1B versus broad global PE portfolio, private equity benchmarks can be broken down into four main types:

  • Compare a fund or portfolio to the industry
  • Compare a fund or portfolio to the public markets
  • Compare the industry to the public markets
  • Compare a fund or portfolio to the public markets and compare that to how well the private equity industry did relative to the public markets

Finally, when you establish a robust benchmark to evaluate the performance of an actively managed portfolio, consider to what extent multiple measurements will allow for a more holistic view. Are you capturing quantitative and qualitative measures over both short- and long-term periods? This is the kind of data that will help your firm have the necessary big-picture view you need to make informed investment decisions.

Technology to Streamline Benchmarking Process

 

Today’s data analytics solutions can help your firm eliminate unnecessary risk by ensuring your team is always looking at a single source of truth. Not only can you increase the transparency and accuracy of the data you collect, your firm can also gain critical back-end efficiencies when you chose a solution designed specifically for private equity.

Altvia’s Answers, for example, is designed to help firms connect data from disparate sources and easily gather meaningful information they can use to create more powerful benchmarks. With a central repository for all of your firm’s data—and analytics you can use without asking your IT department for help—your firm can also quickly access the information investors request and need to make decisions.

Adopting tools designed for private equity can help your firm deliver a trusted, transparent experience to stakeholders and investors—and stand out from the competition.

Global Benchmark Considerations

 

Today, many private equity firms use U.S. benchmarks like the S&P 500, but some firms are beginning to recommend a switch to a more global or blended benchmark system. If this trend takes off, expect a slow progression, as changing a benchmark is a complex process requiring the approval of a firm’s board.

For now, investors should take care to understand what’s being measured, how it’s being measured, and what is being used to benchmark returns.

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