As Buyouts reviews top-performing LBO funds in our feature story this issue, consider the following anecdote reported in the Nov. 9, 1992, edition of this magazine.
An investment advisor told the magazine’s editor at the time, Ted Weissberg, about a pair of buyout pros who stopped by as part of their road show to raise a new fund. Having examined the fund’s offering memorandum, the fund advisor was a bit perplexed by the calculations the general partners used to generate their previous fund’s IRR.
In particular, it seemed to the fund advisor as if the buyout pros had erred in valuing the portfolio companies that had already gone public because the value they ascribed was well above the stocks’ trading ranges, Weissberg wrote. “We don’t feel the public market values the securities fairly,” one of the general partners responded. The meeting didn’t last much longer.
Weissberg went on to write about all the ways that GPs can attempt to buff their funds’ numbers to make them shine as brightly as possible. “There are a million ways to calculate these returns,” one fund tracker told Buyouts. Firms can cherry-pick the best investments, for instance, while playing down the less memorable portfolio companies. Sometimes firms don’t dollar-weight their portfolio and take a simple average of the returns achieved by various investments, Weissberg wrote. This allows firms to inflate the performance of strong companies that required small amounts of equity while obscuring the performance of bigger-dollar dogs. One limited partner told Weissberg he skipped past that potential pitfall by looking at the IRR of the entire portfolio, while another said he simply recalculated all the numbers handed to him by GPs.
For this issue, Buyouts didn’t let the GPs do the talking. Instead, we went to the public pension funds and advisors that make their return data public. We have a feeling they are valuing their fund investments fairly, or at least without concern for how it makes the GPs feel.