Understanding Private Equity Performance
The J-CURVE Effect: Earning Acceptable Returns Takes Time
In the early years, private equity funds will show low or negative returns. The investment gains usually come in the later years as the companies mature and, with the help of the General Partner, increase in value. The effect of this timing on the fund's interim returns is known as the J-Curve Effect.
In the initial years, investment returns are negative due to management fees, which are drawn from committed capital, and under-performing investments that are identified early and written down. It can take several years for the portfolio valuations to reflect the efforts of the General Partners. Over time, progress is made by investee companies and justifies a value for the business that is higher than its original cost, resulting in unrealized gains. In the final years of the fund, the higher valuations of the businesses are confirmed by the partial or complete sale of companies, resulting in cash flows to the partners. In practice, a private equity portfolio involves a series of J-Curves because funds are invested in at different times. However, not all funds will be profitable given the inherent risks of investing in private equity, including macroeconomic factors and the performance of underlying companies.
Valuation & Performance Measurement
In the first year of a private equity fund, investments are carried at cost. In subsequent years, the sale of portfolio companies or public offerings of their shares results in cash and/or stock distributions to the Limited Partners. Over time, increasing proportions of a fund's performance reflects actual cash distributions received, rather than valuation estimates. The most widely used measure of performance is the internal rate of return (IRR). The calculation of the IRR takes into consideration the timing of cash contributions and distributions to and from the partnership and the length of time an investment has been held. Another widely accepted measure of performance is using an investment multiple. This measures the proceeds received from a fund plus the valuation of the remaining investments divided by the capital contributed to the fund.
Although the General Partners report valuations to the Limited Partners quarterly, we monitor fund activities on an ongoing basis through regular communication with the General Partners. While there are no current industry standards for valuations, reporting, and performance benchmarking, we are focused on working with industry associations (such as the Institutional Limited Partners Association and AIMR) to address these issues.
Since inception in 1990 to December 31, 2011, the PE Program has generated $20.2 billion in profits for CalPERS. Given the young, weighted-average age of the portfolio (5.9 years) this amount will continue to grow as the portfolio matures.
To view PE Program performance information, please use the links below.
Additional ResourcesPE Program Performance Overview (PDF, 315 KB)
PE Program Fund Performance Review