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FRM Part II · FRM Exam Part II · Private Markets Investing

A fund-of-funds manager explains why IRR can mislead when comparing two private equity funds. Which statement is correct?

IRR implicitly assumes interim cash flows are reinvested at the IRR itself. That makes funds that return capital early, or delay calls, look better than they may be. IRR is money-weighted and timing-sensitive, unlike a multiple such as TVPI.

  1. AIRR is time-weighted, so it is unaffected by the timing of capital calls and distributions
  2. BIRR implicitly assumes interim distributions are reinvested at the IRR itself, which can overstate performance for funds that return capital earlyCorrect
  3. CIRR ignores the timing of cash flows and is therefore equivalent to the multiple of invested capital
  4. DIRR is always lower than TVPI-implied annualized returns for funds with early distributions

Explanation

IRR is money-weighted and depends on cash flow timing; it implicitly assumes reinvestment at the IRR, which flatters funds that distribute early or use subscription lines to delay calls. It is not time-weighted and is not equivalent to a multiple.

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