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Private equity’s IRR claims slammed as “fake news”

by The Drawdown 6 September 2018

Investors enticed by private equity’s claims of bullish performance could find they are built on “fake” foundations, the founder of a wealth management outfit has warned.

Preston McSwain, the managing partner of Fiduciary Wealth Partners (FWP), urged LPs to challenge the stats on IRR they receive from GPs, database indices and quartile rankings. “If you look closely, my strong bet is that you will start to notice that most every headline return chart or quote that you see or hear is a fake news IRR,” said McSwain, himself a former part of the industry after spending over a decade (1998-2009) at GP Neuberger Berman.

The FWP founder came upon his so-called “findings” after he set out to investigate the “strong belief” in the outsized returns of private equity, an asset class that reaped hundreds of billions in LP money worldwide last year. He shared several personal anecdotes after having examined reports and presentations and taken part in seminars and PE fundraising calls.

McSwain reports reading a GP presentation where figures on strong IRR outperformance were followed – “at the very back of the 50 page plus” document, according to him – by a line where the GP stated that “no client received the returns.” “By the firm’s own admission”, argues McSwain, the performance claims being marketed to LPs were “fake news”.

For private equity, McSwain’s criticisms come as the industry faces scrutiny over the performance story it tells LPs and other stakeholders. In particular, the adequacy of the IRR indicator as a metric able to accurately reflect returns is being questioned from some industry corners.

Speaking to The Drawdown this summer, long-time IRR detractor Oliver Gottschalg rued the “pollution” the indicator has historically caused with reporting, particularly as the market embraces bridge financing. According to him, IRR metrics remain popular as they “tend to make people look much better than worse” but perceptions are changing. “I rarely have a conversation with an LP or GP where we don’t talk about the issue of financing lines,” he said. “People are aware they can distort fund performance conveniently.”

McSwain’s piece documents the criticism that IRR stats have triggered among consultants since at least the last decade. In his view, among the key issues with the metric is its assumption that future investments will produce the same returns as past investments. Another problem, he added, is the circumstance that some GPs will not factor in additional fees as part of their IRR calculations.

The critique of private equity’s performance reporting emerges weeks after Preqin figures indicated the asset class remains the most expensive alternatives allocation option for LPs. The finding comes despite the building campaign for GPs to charge lower– and be more transparent about– management fees.

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