Capital Implementment Matters: A smarter way to assess PE -Rendents – CFA Institute Enterprising Investor

In the past two decades, investors have deposited capital into private assets, signed by the promise of higher returns than public markets. But as Ludovic Phalippou emphasizes in “The Tyranny of Irr”, many investors start to wonder if Private Equity (PE) returns really deliver on their internal returns (IRR) figures.

An important reason for the mismatch lies in Partial investment. In contrast to public assets, PE funds gradually call capital and return it in phases, which means that a large part of the dedicated capital can be inactive for years. This reduces the profit of the investor, even if IRR remains high.

IRR connects the problem by considering only to consider capital by the fund manager, not the full amount that is contributed by the investor. As a result, it exaggerates the performance and hides the resistance of unused capital. To understand what investors really earn, we need a statistics that record this dilution.

Enter the capital deployment factor (CDF) in a simple but powerful tool that measures how much of the capital deposited has been put to work. It not only reveals how much was used, but also how much profit was lost Due to partial investments.

The CDF quantifies the impact of partial investments by showing which part of the deposited capital was actually used to generate returns. Because profit is proportional to the CDF, it also indicates how much potential return has been forfeited by inactive capital.

What does the CDF reveal about the impact of partial investments on real PE funds? It shows that it is very significant, because the CDF of PE funds rarely exceeds more than 60% during their lifetime and usually falls to between 15% and 30% at the time of liquidation.

A side effect of partial investments is that IRR becomes unreliable for comparing performance: Funds with the same IRR, but different capital installation levels can yield very different profits than the same capital that has been paid. On the other hand, the CDF enables the IRR to calculate that a fund should match the profit of another fund or a liquid active for the same capital.

Capital deployment factor

The CDF shows the group of the amount paid by the investor that was used by the PE Fund Manager. It can be calculated at any time to know the IRR, TVPI and the duration of the fund.

The TVPI is the total value for paid indicator at time T, IRR is the internal return since the start is expressed on an annual basis, and the number of years that has elapsed from the beginning to time t. A PE fund with an IRR = 9.1% per year and a TVPI = 1.52x, after 12 years:

What does this CDF figure mean? It means that during the 12 -year period, only 28.2% of the capital paid by the investor was used by the fund manager to generate the profit. In other words, just over one dollar in four was used to produce wealth.

The IRR and TVPI figures above have been compiled by Phalippou from a huge and renowned PE fund database. Irr = 9.1% per year that the median IRR represents PE funds in the database, and TVPI = 1.52x, their average TVPI. The duration reflects the average lifespan of 12 years from a PE fund. The CDF = 28.2% is therefore broad representative of the Mediane PE fund on its date of liquidation.

How does the CDF influence the investor? The impact of partial investments is considerable, because the profit is reduced in relation to the CDF, as evidenced by the reinforcement comparison:

Dugan_T is the total amount that the investor has paid in a maximum of time t and Earn_Tthe profit at time t. Thus, the Mediane PE fund sees its profit reduced by a factor of 0.282 due to partial investments.

What is the typical reach of the CDF for PE funds? It varies during the life of the fund. We found that it is rarely higher than 60% during its lifetime and falls somewhere between 15% and 30% in liquidation. Venture capital funds and primary funds usually have higher CDFs than buyout funds, as illustrated in Figure 1.

Figure 1.

Who controls the CDF? The CDF is determined by the PE fund manager, because the manager alone decides on the timing of currents. The CDF increases if the manager calls the capital earlier. The CDF also increases if the payments are postponed. If the full amount is engaged in the beginning and both capital and profit are reimbursed at the end of the measurement period, the CDF is 100%.

Compare returns

Two funds are equivalent in terms of performance when they have generated the same profit of the same amount paid. This formula expresses this equivalence criterion by giving the IRR that Fund A must have if it has to generate the same profit as fund B from the same amount paid.

Let’s look at an example:

• Fund_(A): Dur = 12 years; CDF = 20.0%; Irr =?.
• Fund_(B): Dur = 12 years; CDF = 28.2%; Irr = 9.1% per year.

Which IRR should finance A that his performance is equivalent to those of Fonds B?

Thus Fund A must have an IRR = 11.26% per year to equate its performance to that of Fund B, which has an IRR = 9.1%. The reason is that Fund A’s manager used less of the resources at his disposal than the manager of Fund B, which is reflected in their respective CDFs. If fund A has an IRR larger than 11.26%, it is considered better performance.

Now let’s assume that Fund C has a CDF = 100% and the same duration as Fund B. For Fonds C to have equivalent performance to finance B, IRR can be much lower on:

A CDF = 100% implies that the amount paid remained fully invested during the 12 -year period, without interim cash flows, the capital and the profit that is recovered by the investor at the end of the period. This would be the case for an investor who bought the same amount of a public property and sold it 12 years later. For him, an average growth rate higher than 3.55% per year would be sufficient to exceed funds A and B.

Important collection restaurants

• IRR can mislead: A 10% IRR on a PE investment of $ 1 million can only yield $ 30,000 – not $ 100,000 – because much of the capital was not actually deployed.
• Irr ignores inactive capital, Because it only calculates returns on the actually planned capital and the fate of non -invested funds.
• The capital implementation factor (CDF) is the most important ratio To analyze the impact of the capital policy of a PE fund and its consequences for the outcome of a PE investment.
• The large empirical paradox: Although there is mandatory empirical evidence that private assets tend to exceed public assets, the actual outcome for PE -investors often cannot reflect this superiority because of the impact of inactive capital. So it is not private assets that are a performance problems, but rather PE -funds such as investment vehicles.
• IRR -comparisons are inadequate: Funds with the same IRR, but different levels of capital implementation generate different actual profits for the same amount that has been paid.
• PME shares the blind spots of Irr: Just like IRR, the public marketquival (PME) has not taken into account inactive capital.

Institutional investors need full statistics. The most important indicators for measuring performance do not reflect the real result for the investor, because they take into account neither the initial commitment, nor the proceeds of cash pending call and cash that is returned by the PE fund. Orbital assets method (OAM) offers a solution:

• Treats the dedicated capital as a whole – including what is outside the PE fund.
• Measure the performance of both the PE investment and the surrounding liquid assets.
• OAM performance figures are similar to those of other assets.

References

Ludovic Phalippou, “The Tyranny of Irr: A Reality Check on Private Market Returns”. Entrepreneurial investor, November 8, 2024, https://blogs.cfainstitute.org/2024/11/08/the-tyranny-of-rr-a-reality-check-on-private-market-returns/.

Xavier Pintado, Jérôme Spichiger, Mohammad Nadjafi, The Canonical Form of Investment Performance (July 2025), coming at SSRN.

Xavier Pintado, Jérôme Spichier, are IRR versions of private equity funds comparable? (November 2024). SSRN: https://ssrn.com/abstract=5025824 or http://dx.doi.org/10.2139/srn.5025824.

Xavier Pintado, Jérôme Spichier, The Orbital Assets Method (2024). Available at SSRN: https://ssrn.com/abstract=5025814 or http://dx.doi.org/10.2139/srn.5025814.