IRR, TVPI or DPI: which fund number to trust

A fund report states three performance numbers, and they answer three different questions. DPI says how much cash has come back for every euro paid in. TVPI adds what the manager believes the remaining holdings are worth. IRR turns both into an annual rate, and it is the only one of the three that can be raised without the fund earning one more euro. Our reading as a limited partner: DPI is a fact, TVPI is an estimate, IRR is a statement about timing. Which one deserves your attention depends on how old the fund is.

One fund seen through all three numbers

Say you committed EUR 500,000 to a fund. It calls EUR 100,000 today, EUR 150,000 after one year, EUR 150,000 after two and EUR 50,000 after three. It distributes EUR 80,000 after four years, EUR 120,000 after five and EUR 70,000 after six. At that point, six years in, the capital account shows a net asset value of EUR 405,000.

You have paid in EUR 450,000 and received EUR 270,000. DPI is 270 divided by 450, so 0.60x. The residual value, RVPI, is 405 divided by 450, so 0.90x. TVPI is the sum, 1.50x. The net IRR on these dated cash flows, with the NAV treated as a final payment, is 10.0 per cent.

All three numbers are correct. None of them is the whole fund.

What does DPI leave out?

DPI ignores everything that has not been paid out. At 0.60x this fund looks like a loss, although three fifths of its total value still sits in the portfolio. In a young fund DPI is zero by construction and says nothing about quality.

Its strength is that nobody had to estimate anything. Cash arrived in your account on a date you can look up. The longer a fund runs, the more of its story DPI tells, and in a fund's tenth year a low DPI is the question to put to the manager, whatever the other two numbers say. We wrote last year about why LPs started asking for DPI first.

What does TVPI leave out?

Two things: time, and who produced the number. A TVPI of 1.50x after six years and a TVPI of 1.50x after twelve are different results, and the multiple does not tell them apart.

The second gap is larger. In our example 0.90 of the 1.50 is NAV, a valuation the manager sets each quarter under its own policy, often anchored to the price of the last financing round. That is an honest estimate in most cases. It is still an estimate, it arrives a quarter late, and it has not been tested by a buyer. When you read TVPI, look at how much of it is RVPI. The quarterly report shows both.

Check also that the multiple is net. A gross multiple is measured before management fee and carried interest. What your own cash flows produce is always net.

What does IRR leave out?

The amount. A holding that returns 1.4 times the money after one year has an IRR of 40 per cent. A holding that returns 2.5 times after eight years has an IRR of 12.1 per cent. The first number wins every ranking; the second left you with far more money, unless you found another 40 per cent a year for the seven years that followed.

IRR is also unstable early in a fund's life. With only a few cash flows and a NAV that is close to cost, a small revaluation swings the rate by many points. After three years, with EUR 450,000 paid in, a NAV of EUR 430,000 gives our fund an IRR of minus 2.7 per cent and a NAV of EUR 470,000 gives plus 2.6 per cent. That difference is one valuation memo.

And IRR depends heavily on the dates of the first payments, which brings us to the part a manager can influence.

How a subscription line raises IRR without raising returns

A subscription line is a bank loan to the fund, secured by the investors' unfunded commitments. The fund buys its first companies with the bank's money and calls the investors later. That is convenient: fewer, larger calls instead of many small ones. It also starts the IRR clock later, because IRR counts from the day your money leaves your account.

Take the same fund and let it finance the first two investments through such a line for one year each, at 5 per cent interest. You now pay nothing today, EUR 105,000 after one year, EUR 157,500 after two and EUR 200,000 after three. Distributions and NAV are unchanged.

The fund owns the same companies and sold them at the same prices. You paid EUR 12,500 of interest, both multiples went down, and the IRR went up by 1.8 points.

This is not our invention. The Institutional Limited Partners Association shows the same effect in its guidance of June 2020: in its notional example the IRR rises from 6.62 per cent without a line to 7.14 per cent with a one-year line and 7.98 per cent with a two-year line, while TVPI falls from 1.45x to 1.40x and 1.35x. ILPA recommends that managers report net IRR with and without the facility every quarter, together with the size and balance of the line. It also cites an analysis of 498 funds in which the median IRR uplift was 206 basis points by the third year and shrank to 35 to 45 basis points by the end of the fund's life. The distortion is largest exactly when a manager is raising its next fund.

There is a second consequence the guidance points out. Investments bought with the line are already in the portfolio although you have not paid for them. Your unfunded commitment looks larger, and your exposure smaller, than they really are.

Which number for which stage of the fund?

In the first three years, none of them. The fund is in the trough of its J-curve, fees weigh on a small base, and the IRR is noise. What you can check is whether calls match the pace the manager announced and what share of them went into fees.

From roughly year four to year seven, TVPI carries the information, read together with its composition. A rising TVPI that is entirely RVPI is a promise. A TVPI that is flat while DPI climbs is a fund turning paper into cash.

After that, DPI. And IRR last: it is a fair number for a fund that is largely realised, compared with funds of the same vintage and strategy. Across vintages, or against a share index that reports a time-weighted return, it compares nothing.

Compute your own

The IRR in the report is the fund's, measured from its first call across all investors, in the fund's currency. Yours differs if you joined at a later closing, if you invest from another currency, or if the report shows a gross figure. The only IRR that describes your investment is the one computed from your dated calls and distributions and your share of NAV. A spreadsheet's XIRR function does it; Valued computes net IRR, TVPI and DPI from the booked cash flows for the same reason.

If your manager uses a subscription line and the report shows one IRR only, ask for the second one. ILPA's paper is the reference to cite, and a manager who has the number will send it.