From The Editor

Has our industry done a good enough job of providing investors a true read of investment performance? And has it done a good enough job of communicating what those measures mean to the public? I don’t know the answers. But on the second question I have my doubts.

Reports in the mainstream press often fail to make a distinction between internal rates of return used to measure private equity performance and the compounded annual returns used to reflect performance in the public equity markets.

In a story this January about how The Blackstone Group was gobbling up local companies in California, for example, the Los Angeles Times reported that the California Public Employees’ Retirement System had “notched a 37.5% annual gain on its $84-million investment in a Blackstone fund that opened in 1994—almost quadruple the gain in the benchmark Standard & Poor’s 500 index over the same period.”

Really? Taken literally that would be one heck of an investment. A 37.5% annual gain over just 10 years would multiply your money by 24.2x. Did the $84 million that CalPERS fortuitously invested with Blackstone back in 1994 really blossom into well over $2 billion? Not according to the latest fund performance data posted by CalPERS on its Web site. There you can look up Blackstone Capital Partners II LP, the vintage 1994 fund referenced in the article, and find that the pension fund has indeed recorded a 37.5% return as of June 30 2006—but, of course, it’s a net internal rate of return, far different from the kinds of annual gains logged in the stock market.

You’ll also see that between distributions of $171.5 million and an estimate of $9.1 million for the remaining holdings, CalPERS has seen its $84 million investment in Blackstone II turn into $180.6 million, for a 2.2x multiple. In my book that’s still plenty respectable. However, it’s a far cry from a 24.2-times multiple and a windfall of $2 billion. And, in fact, the pension fund might well have done better parking the $84 million in the stock market over that period. An 8% annual return on your money over a 10-year period also produces a 2.2-times multiple.

So the Los Angeles Times may have left readers a false impression about the performance of Blackstone’s fund. But am I not guilty of the same thing in presenting the net IRR and investment multiples listed on the CalPERS Web site? Personally, I have no knowledge just how conservatively or aggressively Blackstone is valuing its remaining holdings in that fund. My understanding is that general partners take different approaches on the matter. In addition, Blackstone presumably drew money down from CalPERS over a period of years, and returned it at irregular intervals over another period of years. Net internal rates of return are designed to reflect that irregularity, jumping when distributions come back quickly. But just how valuable is it for investors to get quick distributions? And what if a firm takes a painfully long time to draw down money?

I welcome your comments at