It’s not a “J”, it’s an “S”!  Coming out from the DaRC Room, that’s what the picture is telling!


It appears that private equity fund investments, like many other phenomena in nature and in the economy, behave in a way that can be better described by a sigmoid function.

What plotting over time compounded Duration adjusted Returns on Capital (DaRC) shows is that there is a point in the life of a fund when returns turn from marginally increasing to marginally decreasing.

There are two main explanations for this behaviour:

  1. Distributions – over time, with divestitures, there is less capital at work in the fund;
  2. Marked to “expected future exit value” NAVs.

The first is the realization of a key positive element (i.e. the turnover of the capital) associated to private equity, even if the cash in-flows pose to the investor the challenge of dealing with reinvestment risk.

The second is instead the manifestation of a less virtuous tendency that has also been detected in a 2012 study on venture capital returns, written by professionals of the Ewing Marion Kauffman Foundation, and in a recent academic paper on fair valuation practices, both of which show that valuations tend to be inflated during fundraising periods.

The authors of the latter study also find that interim IRR and PME performance information are of little use in predicting ultimate returns – and when they are, this is true only ex post and for academic purposes, when future public market returns are known.

More to come on the topic. There are plenty of implications, in particular in the areas of pricing and risk management, once we discover the DaRC side of the J-curve. Stay tuned!