Private market funds generate distinct cashflow and returns profiles compared to public market peers. We break down the key terms of which you need to be aware.

Ashley Wassall, Content Lead at Schroders

What is the J-Curve?

This is the name for the returns profile experienced by investors in traditional, closed-end and fixed-term private markets funds.

During the first few years of a fund’s life, cashflows are typically negative, as management fees are charged while capital is being called and invested, and before value creation is realised in underlying assets.

Over time, the returns from the underlying portfolio should turn performance positive – and momentum should gather pace in the later years of the fund’s life, as managers switch to harvest mode (when most investments are realised and the fund returns capital to investors) and exit events and distributions occur more frequently.

The result can be a hockey stick-like return profile, known as the J-Curve (see chart).

_{Past performance is not a guide to future performance. Source: Schroders Capital, 2024. Chart is for illustrative purposes only. Forecasts and estimates may not be realized. 1. Multiple by which the money paid back to the investor exceeds the money paid into the fund.}

How does this work for evergreen and listed funds?

The situation is very different for established open-ended evergreen or semi-liquid funds, such as long-term asset funds (LTAFs) in the UK and European long-term investment funds (ELTIFs).

As these funds already have an investment portfolio that has had time to generate value and distributions – and they have no fixed end date, with capital from ongoing subscriptions being used to fund new portfolio investments – there is no period of negative cashflows, and so no J-Curve effect. For that matter, new subscriptions are essentially “invested” as soon as they are accepted into the fund, meaning investors gain immediate exposure to the asset class.

Listed investment trusts, by contrast, are closed ended – meaning the portfolio is self-contained and self-financing, and investors merely buy and sell shares in the company like any other public stock. Their return is based on share price changes and any dividends paid over time.

This means that while returns are ultimately determined by the quality and performance of the portfolio, they are not directly tied to its value – as any trust manager with a share price that reflects a discount to portfolio value will tell you. There is therefore similarly no J-Curve effect, and exposure to the asset class is also immediate.

How are returns measured in private market funds?

Now that we have covered the return profile of a private markets fund, it is worth covering the different ways the quantum of return can be measured over the life of an investment. Some key terms to understand are:

Net Asset Value

This is simply the fair market value of the fund’s portfolio at a point in time, minus its liabilities. This is the figure used by all private markets funds to show the absolute value of invested assets.

In the context of investment trusts, this is the figure that acts as a reference point to show the premium or discount at which their share prices trade (share price vs NAV per share). Semi-liquid funds, by contrast, are priced at the NAV of the underlying assets, meaning this is the level at which investors buy (subscriptions) and sell (redemptions) into and out of the funds.

TVPI, MOIC and DPI

The simplest measure of performance for a private markets fund compares the total value it has generated, combining both realised returns and the value of unrealised assets, to the capital invested.

This can be expressed either as the total value to paid in ratio (TVPI, measured against the capital paid into the fund by the investor at a point in time), or the multiple on invested capital (MOIC, measured against the total commitment made by the investor). Both figures are expressed as a multiple of the capital invested – so, a 2x return means the investor got back twice the amount they invested.

A related but different metric is the distributions to paid-in ratio (DPI). The DPI is a key performance measure for traditional closed end private funds that reflects the quantum of invested capital that has actually been distributed back to investors at a point in time. It is also expressed as a multiple.

All these numbers reflect the absolute value generated by a fund, but do not adjust for the period over which it was generated.

IRR

The IRR, or internal rate of return, is the most commonly referred-to measure of private equity performance. It is a calculation that aims to show the annualised rate at which returns are generated over the life of a fund, expressed as a percentage. So, if two funds both generate a 2x return multiple (MOIC), but Fund A does this over five years while Fund B does it over eight years, then Fund A will have a higher IRR.

Different funds will target different IRRs depending on how much risk is involved in the investments, and the time horizon over which the returns are being generated.

For example, a traditional secondaries fund that buys investor stakes in existing private equity funds typically generates earlier cashflows and is usually lower duration than a direct buyout fund, because it is invested in already somewhat mature assets. So, it might generate lower absolute returns and have a correspondingly lower return multiple, but could have a higher IRR. Given the earlier cashflows, secondaries investments can also be used by managers or investors to mitigate the J-Curve effect for a wider private equity portfolio.

The benefits of IRR are that is used widely across the industry and, as it is annualised, it provides a measure of the efficiency of performance over time. On the downside, IRR is a somewhat abstracted measure that doesn’t accurately reflect real returns in the same way as a simple return multiple.

TWR

Time-weighted return, or TWR, is a figure that is familiar in the world of public market investing, and that is the most relevant for semi-liquid private market funds. In simple terms, it is a measure of compounded performance over a defined period - so it can be expressed quarterly, annually and so on - and is similarly expressed as a percentage.

The important difference of TWR compared to IRR is that it is measured over multiple time periods and adjusted to remove the impact of investor cashflows, such as in the case of semi-liquid funds, investor subscriptions and redemptions.  

This means that TWR effectively isolates the performance driven by the investment decisions of the manager, and so that would drive investor returns, without any distortion related to the timing of cashflows coming in or out. Of course, by its nature TWR is a less direct reflection of the profitability of a fund over a finite period, so it is less commonly used in traditional closed-ended funds with limited terms.