The internal rate of return (IRR) has long been a standard measure for evaluating private market investments. However, some critics argue that it can be misleading.
Recent industry debates have cast doubt on its reliability, particularly in a modern context where fund structures and market conditions have evolved.
The issue was debated at a high-level roundtable of industry executives held in London in November which probed whether IRR is still a suitable method for valuing private equity and debt investments, or whether the industry should adopt alternative metrics.
Panellists explored the criticisms and continued relevance of IRR, while also considering alternative metrics that complement its insights.
One of the most significant criticisms of IRR is its susceptibility to manipulation, particularly with the use of subscription credit lines.
David Genn, chief executive of investment platform technology provider Goji, highlighted this issue, stating, “You can play around with IRR and make it look better than it is.”
He pointed to scepticism from both new investors and academics, emphasising the need for transparency. Without clear methodology, IRR can present an overly optimistic view, especially if strong early exits skew the metric.
Mark Corbidge, chief executive and founder of Abbeydale Partners, supported this view, adding, “IRR is still a valid calculation. It’s the extent to which that IRR has been manipulated over the years.”
Corbidge shared instances of LPs (Limited Partners) requesting restated IRRs to exclude the impact of subscription lines, demonstrating the metric’s vulnerability to distortion.
Moreover, Steven Tredget, a partner at Oakley Capital, argued that IRR’s relevance diminishes when it fails to align with realizable returns.
“It’s all very well having a very high unrealized IRR money multiple, but it’s increasingly seen as meaningless without demonstrating whether that return is in any way realizable,” he explained.
The Importance of Complementary Metrics
While IRR has its flaws, most experts agree it remains a valuable tool when used alongside other metrics.
Genn emphasized that “sophisticated investors don’t just use IRR to gauge performance,” advocating for the inclusion of multiples and horizon returns.
Multiples such as TVPI (Total Value to Paid-In) and DPI (Distributed to Paid-In) provide a more comprehensive view of a fund’s performance, particularly in terms of capital realization.
Tredget pointed out that DPI is gaining prominence: “It becomes as important in the current environment where there’s been a lot less realizations.” He also noted that the speed of capital return can differentiate managers, as “how quickly we return capital” often matters more than high IRRs or money multiples.
Similarly, Anthony Diamandakis, Citi’s head of Global Asset Managers, suggested that the relevance of IRR depends on strategy. For growth-oriented investments, IRR may remain crucial, while for larger, more stable investments, money multiples take precedence.
Given the limitations of traditional IRR, some experts advocate for modified approaches. Genn discussed the Modified IRR (MIRR), which uses the hurdle rate as a discount factor. “It makes comparing funds within a portfolio much easier,” he explained. MIRR addresses the inconsistency found when averaging IRRs across multiple funds, offering a more standardized and comparable measure.
This approach resonates with the industry’s need for greater precision. As Genn cautioned, “The industry will undermine itself if it’s not way more precise around this.” Modified IRR could bridge the gap between intuitive appeal and rigorous analysis, making it easier to evaluate fund performance across diverse strategies.
Education and Transparency: Key to Adoption
A recurring theme in the discussion was the need for education and transparency around performance metrics. Tom Taylor, head of policy (legal & regulatory) at the BVCA, pointed out that retail and some institutional investors sometimes lack familiarity with the nuances of IRR and its alternatives. “There’s an education piece, not just in the retail space, but institutionally as well, particularly with newer investors in private capital such as UK DC pensions,” he noted.
This underscores the importance of clear communication, particularly when introducing metrics like MIRR or new benchmarks tailored to specific strategies. As Genn remarked, using IRR as the sole performance measure in marketing materials, especially for non-institutional investors, risks perpetuating misunderstandings.
The IRR remains a valid and useful valuation tool in private markets, but its limitations are increasingly apparent. As Genn, Corbidge and other panellists pointed out, the metric can be misleading if not supplemented by additional performance indicators such as DPI and TVPI. Furthermore, the rise of modified metrics like MIRR offers a promising solution to some of IRR’s inconsistencies.
Ultimately, the suitability of IRR depends on its application and the context in which it is used. For a holistic understanding of fund performance, investors must adopt a multi-metric approach while promoting greater transparency and education. As the private market landscape evolves, so too must its valuation methodologies, ensuring they remain robust, comparable, and relevant.
As regulators increasingly scrutinize private markets, the panellists discussed regulatory thinking around the frequency and transparency of private market valuations.
The drive toward more frequent and transparent valuations has sparked debate about operational feasibility, systemic risk, and investor confidence.
Phil Bartram, a partner with Travers Smith, succinctly framed the core issue: “The frequency has to match the liquidity.”
He pointed out that semi-open-ended funds with monthly subscriptions or quarterly redemptions necessitate monthly valuations to ensure accurate performance measurement and investor confidence.
While achieving monthly valuations is operationally feasible for many private market portfolios, it introduces a significant administrative burden.
Diamandakis added that the demand for more frequent valuations may grow as semi-liquid products become more popular. “If a GP can do it monthly or is prepared to do it monthly for some, is everyone going to demand it? Possibly.”
This scenario could in theory push managers toward more frequent valuation cycles, but the question remains whether it would deliver meaningful benefits or simply increase costs.
One area of interest for regulators globally is whether there is the potential for sudden re-evaluations of private market assets to trigger systemic risk.
Bartram highlighted the anxiety regulators face: “People like the Bank of England are talking about… if there’s suddenly a whole raft of re-evaluations of private market assets… does that feed into systemic risk?”
Despite these fears, industry leaders largely believe the concern is overstated. “That’s all misplaced concern, really,” Bartram asserted, emphasizing that current practices are diligent and transparent to investors.
Tredget agreed, noting that private equity valuations tend to be conservative, often adhering to International Private Equity and Venture Capital Valuation (IPEV) guidelines. In fact, Tredget suggested, regulators might discover that private market valuations are sometimes understated, rather than overstated.
Transparency and independence in valuation processes are also under scrutiny. Corbidge shared his experience with external auditors: “We used to have EY come in and do a portion of our valuations… it gives you a certain degree of solidity.” However, Corbidge acknowledged the potential tension between fund managers and auditors, especially when valuations influence upcoming fundraising or marketing efforts.
Bartram expressed concern that regulators might overreach by mandating external auditors for every valuation. “There’s a bit of a worry that regulators might say, you need a Houlihan Lokey or somebody on every deal… I’m not sure that’s really right.” He argued that internal teams, guided by rigorous standards and supplemented by sample audits, can be equally effective without adding unnecessary cost and complexity.
Guy Hume, managing director, Private Capital Advisory at Raymond James, brought up a nuanced issue in the context of GP-led secondary transactions, where valuations play a critical role.
“The way the process operates with most secondary investors is they look at the last quarterly mark and work to a discount or premium to that.” He noted this potentially creates an incentive for managers to influence valuations upward in anticipation of secondary sales, although he also emphasized that this is indicative of PE valuations being typically conservative.
Tredget pointed out that past problems in non-performing entities (NPEs) often stemmed from undervaluation rather than overvaluation, leading to significant premiums upon sale. “The problem with NPE was the undervaluation of assets… we sold at least at a 50% premium,” he said.
With the UK’s Financial Conduct Authority (FCA) and the International Organization of Securities Commissions (IOSCO) conducting reviews, the industry is awaiting formal regulatory feedback. Bartram shared his expectation that regulators will ultimately be “pleasantly surprised” by the quality and diligence of current valuation practices. However, he warned against imposing prescriptive measures that could stifle operational efficiency.
Taylor expressed hope that a positive regulatory outcome could bolster trust in private markets: “I hope the results of the FCA look at this will… be quite positive… a positive platform for inspiring more trust in these robust processes.” However, he also acknowledged the challenge of balancing regulatory oversight with practical considerations, particularly in the context of UK defined contribution (DC) pension schemes, where valuations can more directly impact unit pricing and individual returns.
If regulators push for more frequent valuations across all private market funds, managers could face significant operational challenges. Corbidge recalled a time when private equity valuations were more conservative and less frequent, driven largely by investor relations. “Over time… investor relations dragged those valuations higher… now the valuations are probably about where they should be.”
Tredget highlighted the potential risk of spending excessive time on administrative tasks rather than value creation. “The realism of actually rebudgeting every month… you just spend your entire time forecasting,” he noted.
As regulators continue to scrutinise private market valuation practices, the industry faces the possibility of increased demands for frequency and transparency. While there is broad agreement on the importance of robust and transparent valuations, industry leaders caution against regulatory overreach that could burden fund managers without delivering commensurate benefits.
Ultimately, a balanced approach—recognizing the operational realities of private markets while safeguarding investor interests—will be key. If regulatory bodies acknowledge the diligence and conservatism inherent in current practices, they may find that existing frameworks already provide the necessary safeguards against systemic risk.
The final topic considered by the panel was the future of environmental, social, and governance (ESG) in private markets regulation.
As ESG considerations gain prominence, regulators are increasingly turning their attention to private markets. While private equity and debt investments play a crucial role in the global economy, integrating ESG factors into regulatory frameworks presents unique challenges and opportunities.
ESG Labels: A Challenge for Private Markets
One of the key issues discussed was the potential introduction of ESG labels for private market funds, with Bartram highlighting the complexities around such labelling.
“Policy makers are saying that for at least retail money and… private wealth, you need ESG labels that tell investors something about portfolio composition,” he said. “We haven’t got that at the moment.”
While the UK has initiated ESG labelling for mutual funds through the Sustainability Disclosure Requirements (SDR) regime, extending similar requirements to private markets may prove difficult.
Bartram noted that in the EU, discussions are ongoing under the Sustainable Finance Disclosure Regulation (SFDR) 2.0 framework. However, he expressed scepticism about investor uptake in private markets due to the mismatch between rigid labels and the value-driven nature of private equity and debt investments.
Taylor echoed this concern, warning that applying labels could inadvertently create shortcuts in investors’ sustainability due diligence (DD) processes and “influence behaviour in the wrong direction.”
Beyond environmental factors, diversity, equity, and inclusion (DEI) considerations are increasingly influencing private markets.
Corbidge shared an anecdote from a Grosvenor SME conference where a New York City Comptroller’s representative explained that private equity funds had to meet DEI standards to qualify for investment from any NYC funds. “That’s a big pot of cash for one individual to have the pen over… and I think that’s proliferated now in other areas of the US,” Corbidge noted.
Hume added that diversity considerations can now be influential upon deal prioritisation. “Our distribution team tells us that when certain investors receive a deck, they look at the team page… if there’s insufficient diversity, it either goes in the bin or gets deprioritised straight away.”
This trend underscores the market-driven nature of ESG, where investor preferences can influence manager behaviour without requiring regulatory mandates.
Disclosure vs. Performance Mandates
A key regulatory debate is whether ESG requirements should focus on disclosure or performance with Tredget observing that current regulations are primarily centered on disclosure: “So much of the regulation per se is around disclosures… enabling anyone from the consumer to the investor to take a view on the metrics they see as important.”
He noted that the question for the future is whether regulations will mandate specific ESG performance targets, such as achieving net-zero carbon emissions by a certain date.
Bartram argued that while fund-level transparency is essential, mandating performance targets may not be appropriate. “The only real agents who can actually affect decarbonisation are the companies… mandating that at fund level doesn’t make sense.” He suggested that regulatory efforts should focus on enabling transparency, allowing investors to make informed decisions while leaving room for market forces to drive ESG performance.
Balancing Reporting Burdens with Growth
Another significant challenge is balancing ESG reporting requirements with the growth needs of private market investments, particularly in younger, high-growth companies.
Taylor pointed out that imposing heavy reporting burdens on such companies could stifle their growth. “It’s not appropriate to put significant reporting burdens on small, fast-growing companies in the same way as on large listed companies.”
Tredget agreed, emphasizing that many of the private market investments tend to be in “higher growth, new economy businesses which… by their nature tend to be slightly more sustainable.”
However, these companies should not be penalized by reporting requirements that make them appear less appealing from an ESG perspective. Taylor suggested that regulators must find a way to ensure that these businesses can remain competitive while meeting necessary ESG criteria.
Cross-Border Investments and Global Standards
Aligning ESG regulations across jurisdictions presents both challenges and opportunities for private market participants. Corbidge highlighted that the rising regulatory hurdles in different regions might contribute to the trend of deal-by-deal investing. “Maybe it’s the regulatory hurdles… leading to this ballooning of deal-by-deal investments, because you don’t have to go through the brain damage of a fund and everything that goes with it.”
Hume added that emerging trends such as continuation vehicles (CVs) and semi-liquid products are creating new avenues for private market investments. He noted that ensuring consistency in ESG standards across this proliferation of vehicles could present a challenge, especially for cross-border investments where regulatory frameworks differ significantly.
There was consensus among panellists that while regulatory frameworks are necessary, market forces will play a significant role in shaping ESG practices.
Corbidge suggested that market preferences are already driving better ESG behaviour: “Do you actually need strict regulation or do market forces decide where the allocations are going to go anyway?” he asked.
Tredget concluded that regulation should focus on ensuring clear, standardised disclosures, allowing market forces to reward high-quality, sustainable investments.
The future of ESG in private markets regulation will likely be shaped by a combination of regulatory mandates and market-driven forces.
While transparency and disclosure are essential for building investor confidence, imposing rigid performance targets or reporting burdens may hinder growth, particularly for high-growth companies. Aligning global standards remains a key challenge, but as Corbidge noted, market forces are already influencing behaviour in positive ways.
Ultimately, the success of ESG regulation in private markets will depend on striking the right balance—encouraging sustainable investment without stifling innovation and growth.
As regulators and market participants continue to navigate this evolving landscape, collaboration and flexibility will be critical in shaping a framework that supports both financial returns and positive societal impact.
THE PANEL
Phil Bartram, partner, Travers Smith
Mark Corbidge, chief executive and founder, Abbeydale Partners
Anthony Diamandakis, head of Global Asset Managers, Citi
David Genn, chief executive, Goji
Guy Hume, managing director, Private Capital Advisory, Raymond James
Tom Taylor, head of policy (legal & regulatory), BVCA
Steven Tredget, partner, Oakley Capital
Mark Latham, deputy editor, Funds Europe (Moderator)
A further report on the high-level policy dialogue looking at the challenges of the distribution of AIFs and the democratisation of private markets funds can be viewed here.
A flip-thru PDF of the print version of these reports can be viewed by clicking here.
