Be gone, IRRs! Come June, limited partners will demand a new “cash-in and cash-out” standard for measuring returns on private equity funds.
“IRRs are meaningless,” says Richard Hayes, chairman of the newly incorporated Institutional Limited Partners Association (ILPA) and senior investment officer for CalPERS’ alternative investment program. “Although IRRs are an indication of how a fund is doing in the interim, at the end of the day, if I give you $1, what we care about is that we get $3 back, and when. Unless we get our principal back and cash profits, there’s nothing.”
Hayes revealed the ILPA’s proposals at yesterday’s CalPERS investment committee meeting in Sacramento. “From an LP’s standpoint, ‘cash-in and cash-out’ is what really matters because cash pays the benefits and helps retirees,” he says. IRRs, says Hayes, are inconsistent and misleading. Since IRRs are based on valuations of privately held companies, two funds can calculate different valuations — and different IRRs — for the same investment. A “cash-in and cash-out” reporting standard could eliminate those inconsistencies with a simple and transparent method of calculating returns.
According to the ILPA’s proposal, invested cash would be measured against what is returned to the LP in the form of liquid stock on the day the stock is distributed to LPs. Basically, it’s a vintage-year approach that will look at funds in the years six through 10 — once the investment capital has been deployed and cash and profits already are being distributed — and then compare the returns of a given fund with its peers. Investment committee members Dr. William Crist and Robert Carlson voiced immediate support for the ILPA’s proposal. Hayes will come back to the investment committee with the group’s formal recommendations in June.
For his part, Hayes has been among the most vocal and forceful in demanding transparency in the private equity industry. Since taking over as head of CalPERS’ $20 billion private equity program in July following Barry Gonders’ departure, Hayes has posted fund performance reports on the pension fund’s Web site and has taken on the chairmanship of the ILPA as a means of organizing LPs and promoting research and standards throughout the private equity industry. This month, he distributed a list of capital calls to CalPERS’ investment committee along with his group’s monthly performance report. He plans to add distribution reports to the list over the coming months.