If Not the IRR, Why the PME? Benchmarking requires the ability to objectively generalize results. This is why the development of any financial benchmark is in essence the complex outcome of a rigorous averaging exercise. From this perspective, the currently adopted public market equivalent (PME) methodologies for benchmarking private equity have not overcome the well-known limitations of the internal rate of return (IRR).
PME-based benchmarking exercises fail not only from the formal standpoint of mathematical and statistical accuracy, they also fail on substance. PME does not reflect the economic reality of private equity investing. Indeed, in this respect, it is even worse than the IRR.
PME does not represent a risk-adjusted metric. It implies a relative beta measurement assumption about the underlying public market benchmark without clear market standards as to how to measure the beta of a PE fund.
The widespread use of generalized PME benchmarking outcomes misrepresents the cash and equity nature of self-liquidating private funds. Without consistent underlying data — academia has failed to cover the statistical basics’ bases in this case — generalized PME-based benchmarking exercises are transforming what should be objective valuations into after-hours pub discussions among fans of opposing methodologies.
Now, this is not to say that for a single fund calculating the PME or the IRR is incorrect. Rather, I believe PME and IRR use should be rigorously confined to the realm of single asset valuations. The IRR is a well-known shortcut for net present value (NPV) calculations at the single project level. PME is a relative value variation of this theoretical exercise and is only possible on an ex-post basis.
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