How do you measure return on an investment in private equity? Here's David A. Kaplan's take on it:

In this footnote to his hilarious tale of venture capitalists and their world, Kaplan manages to get to the heart of the IRR conundrum. Yet as
valid as these criticisms are, are they new? Unfortunately not. Two independent teams, one from Richards & Tierney (in 1995), the other from
the team of Austin M. Long and Craig Nickels (in 1996), raised many of the same criticisms and suggested new methodologies for performance measurement.

private i's Benchmarking Module puts these and other variations on these methodologies to work.

One of the main advantages of the private i Benchmarks is that it works directly off your data. From within private i, you can calculate an IRR for any commitment as if it were invested in a benchmark index. You can use the Benchmark IRR to compare performance to any index you want...or dream up. You can model the performance of a portfolio of investments as if they were invested in a benchmark index. With this tool, you can easily answer:

• How would your money have fared if it were invested in an index fund that tracks the S&P?
• How does your performance compare with vintage year benchmark returns from Venture Economics?
• Does your portfolio outperform the S&P by 300 basis points?
• What is the performance of your 1999 Buy Out funds compared to Venture?
• ...

private i Benchmarks helps you answer questions, but it does not pose the questions. You must do that. This is an exact science with a very subjective basis: Make wrong assumptions and you will get precise numbers that may make no sense. It is up to you to take a sensible approach
to comparing fund performance. If you don't believe that the latest two years have significant data, or that that data can skew the result, you should omit these funds from your analysis. If you do not believe that you should commingle Real Estate and Direct Investments, then don't. As well, this process is very computational intensive, and so you can easily spend a lot of time waiting for results to ambiguous questions. Be clear
on your assumptions and the results may surprise you, but should not befuddle you.

"Eliminate the impossible, and what remains, however, improbable, is the truth." - Sherlock Holmes to Watson.

The Richards & Tierney paper stressed the difference between continuous and opportunistic investing.

• In continuous investing, you hand a sum of money over to a money manager and that manager assumes responsibility for that money
  until you end your relationship. In continuous investing, the Time-Weighted Rate of Return (TWR) is widely regarded an appropriate measure. Timing of cash flows is irrelevant. The manager always has your money.

• Opportunistic investing isn't about taking your money all at once. Some of your money is committed to an investment (for example, a Limited Partnership), but capital is only drawn when needed and over time some money may be returned to you. It's widely recognized
  that the IRR is a better measure of this type of investment, but it has an inherent flaw. Austin Long's dictum is to eliminate that which
  is impossible. What is impossible here? In simple terms, the mathematics of the IRR is based on this:

"Take whatever you get from the deal and reinvest it in the deal."

In private equity, this is the one option you do not have. You sign on at a moment in time, pay in over time; get money out; and the deal runs its course. With its somewhat peculiar mathematics, the IRR assumes that you are able to reinvest all distributions back into a deal that performs exactly as the deal does. A more realistic measure would take into account what you can do with the money you commit to the deal before you
pay it in and after you get it out. Both papers suggest that you measure the performance of a private equity investment exactly this way.

1. David A. Kaplan, The Silicon Boys and Their Valley of Dreams, 2000. Perennial. Paperback, page 204.