CFA Level I · CFA Level I Exam · Alternative Investment Performance and Returns

Early in a private equity fund's life, its since-inception IRR is most likely to be depressed relative to its eventual performance because:

The early-life drag is the J-curve effect. Fees and expenses are paid immediately while investments have not yet matured or been revalued upward, so since-inception IRR starts low or negative and typically improves as portfolio companies grow and are exited.

Afees and costs are incurred before investments mature, creating a J-curve effectCorrect
Bresidual values are always overstated by general partners
Cdistributions are reinvested at the IRR automatically

Explanation

Management fees and organizational costs are charged from the start while portfolio companies are still being developed and are often held at cost, so early IRRs are low or negative, producing the J-curve. Overstated valuations would raise, not depress, the IRR. Reinvestment at the IRR is an assumption of the IRR calculation, not a cause of early weakness.

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Early in a private equity fund's life, its since-inception IRR is most likely to be depressed relative to its eventual performance because:

Explanation

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