Correcting Alpha: fundamental flaws of IRR

Although it is the primary comparative performance metric used in the PE industry, the formula for calculating a fund’s internal rate of return (IRR) has several inherent and material flaws. When coupled with some of the natural fund management techniques and efforts of sponsors, those flaws can produce IRR distortions that draw unwanted attention from prospective investors and, potentially, the SEC.

To help sponsors mitigate these risks, this first article in a two-part series describes some of the flaws of the IRR formula and prescribes specific measures general counsels (GCs) and chief compliance officers (CCOs) of managers can undertake to ensure the accuracy of their IRR calculations. The second article will suggest ways prospective investors can perform their own diligence of IRR figures during the fundraising process to acquire the most accurate picture possible of a sponsor’s investment acumen and performance record.

To read the first part of this two-part analysis, head over to our sister publication Private Equity Law Report

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• Topics
• Performance
• GPs
• LPs
• Private Equity Law Report