The investor community increasingly demands that investment performance be calculated without the use of subscription lines of credit. ATP Private Equity Partners, the fund of funds arm of Denmark’s largest pension, has recently changed its due diligence process to request returns without the “flattering effect of subscription lines.” Managing Partner Torben Vangstrup explained, "We need to be able to compare all GPs on equal terms, so we have to actually adjust for the use of credit lines in the performance data. Every due diligence we do going forward, we’ll ask the GP to make that calculation for us."
Though used almost exclusively by private markets managers, the transparency of an internal rate of return (IRR) as a return metric is not a new topic. Much of the focus of this discussion relates to leverage, specifically the use of subscription lines to delay the calling of capital from underlying investors. Vangstrup (like Warren Buffett, May 2019) speaks for many investors when he questions how this type of fund-level financing impacts the overall returns that are presented (both before and after fees).
Essentially, the argument is that IRR alone does not tell the story of how well an investment performed, for two main reasons:
- there is no indication of how much of committed capital is put to work; and
- it does not clearly communicate the impact a fund-level credit facility has on the return generated for a fund or specific investment.
While there is no industry consensus on how to handle this issue, the concept of an apples-to-apples comparison across GPs is one that has long been a “de facto” requirement in the traditional investment management space. The recently released 2020 Global Investment Performance Standards (GIPS®) offer a solution on how to address this issue. The more broadly applicable GIPS standards are more accommodating to a fund structure, built around investment vehicle, where the ability to present IRR is based on the ownership of the timing of cash flows (with a few other caveats that private markets investments would meet). In addition, the changes to the GIPS standards require the presentation of a group of investment multiples whenever firms decide IRR is the most relevant performance metric. These investment multiples help reduce some of the ambiguity associated with IRR by providing insight into the amount of capital invested, and distributed, for specific funds. The 2020 GIPS standards even go as far as to require the calculation of performance returns “without” the use of a subscription line to remove the return generated by using these bridge financing facilities. This echoes guidance released by ILPA in June of 2017.
Alternative investment strategies are seeing record inflows as investors look for higher yields in a low interest rate environment. In turn, there is an increased number of private fund managers and thus, more competition. In seeking a competitive edge, many alternative investment managers will benefit from the enhancements that the 2020 GIPS standards provide, leading to increased rates of adoption in the sector.
ACA Performance Services encourages firms seeking help or advice on calculation methodologies, disclosures for unlevered returns, or implementing the GIPS standards to reach out to Christie Dillard at +1 (866) 279-0750.
About ACA Performance Services
ACA Performance Services provides GIPS compliance verification and consulting services to investment managers around the globe. Our team — comprised of more than 80 professionals with extensive GIPS standards and performance experience — is the largest group of GIPS compliance professionals in the world solely dedicated to GIPS compliance verification and related services.
About the Author
Christie Dillard, CIPM, is Managing Director with ACA Performance Services, a division of ACA Compliance Group. Her primary responsibilities include overseeing business development, onboarding all new clients, and ACA’s education initiatives. Prior to joining ACA in 2007, Christie spent six years in private client banking at two regional banks in Chattanooga. Christie obtained her CIPM designation in 2011 and has served on the CIPM Standard setting in the past. She graduated from the University of the South in Sewanee, Tennessee with honors and is also a member of the CFA Society of East Tennessee.