Case 076Investment evaluation and pitchesCore

A private equity fund reports a 14% net IRR after seven years against an index that returned 13% a year. Using its paid-in capital, distributions and NAV, compute DPI, RVPI and TVPI and judge the fund.

Neuberger BermanLondon · 2022

The situation

Shikhar Growth Fund I, an invented mid-market buyout fund, is seven years old. Its investors, the limited partners, have paid in Rs 800 crore. The fund has sent back Rs 600 crore in distributions and reports the companies it still holds at a net asset value (NAV) of Rs 700 crore. The general partner's quarterly letter leads with a net IRR of 14%.

An endowment that owns part of the fund is deciding whether to commit to Shikhar Growth Fund II. Its analyst points out that a broad public equity index returned 13% a year over the same seven years, and asks you whether Fund I has actually earned its fees and its ten-year lock-up.

Your task

Compute DPI, RVPI and TVPI, compare the fund with the index on a like-for-like basis, and say what you would tell the endowment.

Quick check

Before any maths: how much of Shikhar's reported value has actually come back as cash?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

DPI is 0.75x, RVPI 0.875x and TVPI 1.625x, and the edge over the index is thin and unrealised. After seven years investors have not yet got their money back in cash. Measured over the same effective exposure, the index would have turned Rs 800 crore into about 1.57x, so the fund is ahead by roughly 3%. A 6% markdown of the NAV erases the lead, so Fund II needs evidence that the marks will convert to cash.

Step 1What do DPI, RVPI and TVPI each tell you?

Think of a friend who borrowed money to start a shop. What matters is how much has come back to you, and separately what your share of the shop is worth if it were sold today. DPI counts the cash already returned per rupee paid in; RVPI counts the value still held at the manager's mark; TVPI is the two added together. For Shikhar, DPIDistributions to paid-in: cash returned to investors divided by the capital they have paid into the fund. is 600 over 800, 0.75x. RVPI is 700 over 800, 0.875x. TVPI is 1.625x. A DPI below 1.0x after seven years means the limited partners are still out of pocket in cash terms.

Shikhar Growth Fund I after seven years: what is cash and what is a mark0.5x1.0x1.5xDPI 0.75xRVPI 0.875xTVPI 1.625xShikhar Fund IRs 600 croreback in LPs' handsRs 700 crore NAVa valuation, not cash1.57xIndex, same exposure13% for 3.7 yearsEdge over indexPME about 1.03all of it insidethe unrealised mark
Shikhar Growth Fund I's TVPI of 1.625x is 0.75x of cash returned and 0.875x of unrealised NAV, and against the index's 1.57x over the same effective exposure the fund's small lead sits entirely inside the unrealised mark.
Step 2Why can a 14% IRR and a 1.625x multiple both be true?

A 1.625x multiple earned over a full seven years would be only about 7% a year. The IRR is twice that because a fund does not hold all of the money for all of the time: capital is called in stages and distributions start in the middle years. IRR measures speed and TVPI measures size, and a fund can score well on one by managing the timing of the other. Solving 1.14 to the power d equals 1.625 gives d of about 3.7 years, the effective time the money was at work. That is the clock to use for the index too.

The relationship
d=ln⁡1.625ln⁡1.14≈3.711.133.71≈1.573×1.6251.573≈1.033d = \frac{\ln 1.625}{\ln 1.14} \approx 3.71 \qquad 1.13^{3.71} \approx 1.573\times \qquad \frac{1.625}{1.573} \approx 1.033
dthe effective number of years the paid-in capital was invested
1.625Shikhar's TVPI
1.13one plus the index's yearly return
1.033the fund's multiple over the index multiple, a rough PME
What it says in wordsOver the same 3.7 effective years, the index would have produced 1.57x, so the fund beat it by about 3% in total, not by the one point a year the headline suggests.

The shortcut is rough and you should say so. The proper tool is a public market equivalentA comparison that invests each of the fund's cash calls into an index on the same dates and sells index units on each distribution date, so both are measured on identical timing. using the actual dates of every call and distribution. The wrong comparison, which many candidates make, is 1.625x against 1.13 to the seventh power, 2.35x, which makes the fund look terrible because it pretends the index had all Rs 800 crore for seven years when the fund did not.

Step 3How much should you trust the NAV?

The Rs 700 crore is the manager's estimate of companies not yet sold, usually set by comparing them with listed peers and recent deals. The fund's lead over the index survives only if the NAV is not more than about 6% too high. Below a NAV of about Rs 658 crore, TVPI drops to the index's 1.57x. At a 15% markdown, TVPI is 1.494x and the implied IRR falls to about 11.4%, below the index, before any allowance for the fact that the endowment's money was locked up and could not be sold in a bad year.

How far the NAV mark can fall before the fund trails the index9%11%13%15%0%10%20%30%Haircut to the Rs 700 crore NAVindex 13%As marked: 14.0%Matches the index at a 6% haircut15% haircut: 11.4%
Shikhar's implied IRR falls from 14.0% as marked to the index's 13% at a NAV haircut of about 6% and to 11.4% at a 15% haircut, so the fund's whole lead depends on the unrealised marks holding.
MeasureShikhar Fund IWhat it says
DPI0.75xCash back per rupee in: not yet whole
RVPI0.875xValue still at the manager's mark
TVPI1.625x46% realised, 54% marked
Net IRR14.0%Speed, helped by staged calls and early exits
Rough PME1.03About 3% ahead of the index over the same exposure
Shikhar Growth Fund I has returned 0.75x in cash and reports 1.625x in total, which beats the index only narrowly once both are measured over the same 3.7 effective years.
Step 4What would you tell the endowment?

Private equity asks investors to accept fees, illiquidity and a decade-long lock-up, so the usual expectation is a clear premium over public markets, often a few points a year. Shikhar has delivered a premium too thin to pay for the lock-up, and most of its value is still a mark. Before committing to Fund II, ask for the cash flow dates to run a proper PME, the exit history of the companies already sold against their last marks before sale, and the age and valuation basis of the five largest holdings in the NAV. If past exits sold above their prior marks, the NAV is probably conservative and the case improves.

Where candidates lose it

The common loss is taking the 14% IRR at face value and comparing it with 13%, concluding the fund beat the market by a point a year. IRR is sensitive to timing, and the manager controls the timing; the interviewer wants to hear that you would look at cash returned before believing the headline.

The opposite error is comparing 1.625x with the index compounded over all seven years. That penalises the fund for capital it never held. Measure both on the same exposure, then say how much of the result is still a mark.

What the interviewer asks next

  • The fund used a subscription credit line to delay capital calls by a year. What does that do to IRR and to TVPI?
  • How would you check whether the NAV marks are conservative?
  • What DPI would you want to see before calling Fund I a success?
  • Why might a 1.4x fund with a 2.0x DPI be better than this one?

Asked at Neuberger Berman, Private Equity, London, 2022 (Wall Street Oasis): How would you assess a funds performance, especially a PE funds performance?

Company names and figures are illustrative.