Applying leverage to a public markets index could replicate private markets returns, these observers argue.To test this claim (and putting aside that a leveraged public index investment holds leverage at the LP level rather than the company level as in a leveraged buyout), But maybe that isn’t the right comparison.

However, leverage is not exclusive to the private markets 1, as the chart below highlights. In recent years, subscription lines of credit have evolved beyond this function and now can help manage the fund’s cash, with repayment terms often extending well in excess of 90 days.As Anne Anquillare, CFA, president and CEO of PEF Services, notes:“It is important to distinguish a subscription line of credit that is used to finance investments over a longer period of time versus the typical ‘bridge loan,’ which have strict limits in the use of advances (partnership expenses and for short-term deal financing). The concept of money as a “shared illusion” is being tested. With thanks to Gianluca Moretti for his insight and comments on the treatment of management fees and interest expense in this example.Image credit: ©Getty Images/ Andrea Donetti / EyeEmAntonella Puca, CFA, CIPM, CPA/ABV, CEIV, is a Senior Director in the Valuation Services group of Alvarez & Marsal in New York and the author of Early Stage Valuation (Wiley, 2020). As a result, the IRR will, of course, be “better” due to the math we use to calculate it, but IRR tells nothing about the increased risk (as a result of using debt) … it does not automatically mean that there is additional value created for the investors; we would, of course, know that only after we properly calculate the (increased) discount rate (i.e. How is the company generating cash for the distribution? From this data, investors can then recalculate the IRR based on their own assumptions.“To evaluate the performance of private equity funds,” Carson says, “it is critical for an investor to consider multiple metrics, including IRR, [public market equivalent] PME benchmarks, and multiples of invested capital like the TVPI.

Although we all know that using debt “leverage” is common, the best way to understand why PEGs use debt in the first place is to look an example of what leverage does to investment returns. Thank you for a very good article.Very good. For context on how leverage on the underlying investments in their portfolio compares to the industry, LPs can use tools like Cobalt LP’s Deal Level Benchmarks (powered by Hamilton Lane data).In 2016, Hamilton Lane, a global private markets asset management firm with more than 28 years of experience, together with Bison, a cutting-edge software solutions firm, brought Cobalt to the market. Longer-term subscription lines of credit also enable comparisons between managers that use them and those that do not.In addition to the actual return, inclusive of the effect of the line as incurred by the fund (“with” the line of credit), many investors, particularly on the institutional side, now often ask for adjusted returns (“without” the line of credit) that treat the cash as if it came through a capital call rather than credit facility. These issues should be routinely brought to the attention of LPs.

Now that I’ve re-read Gary’s comment, I realize that he was talking about the LP using the equity capital during the period when the GP is using borrowed capital rather than calling the equity capital, whereas I was thinking about the GP using called equity capital plus borrowed capital.Good article. Ideally, you can filter the industry data to show only deals with similar characteristics, as different sectors or geographies may have different “normal” leverage levels. So, we are delaying the LP cash outflows by using debt. In 2020, Hamilton Lane wholly acquired the Cobalt LP business from Bison, fully bringing the limited partner product in house. Portfolio companies generate it directly through guarantees and debt serviced, while private equity funds generate it through subscription lines of credit guaranteed by the investors’ capital commitments. Net Debt / EBITDA, commonly called a leverage multiple, is a ratio that compares a proxy for the company’s free cash flow to its debt load (less cash) and can be used to judge the financial health of a company. Thank you for the insight! These metrics provide different perspectives on the manager’s ability to generate performance, and it is important to be able to consider all of them to truly understand the strategy and the results of the fund.”1. One point that should also be considered is the return that can be earned on capital during the “deferral period” when leverage is employed.

They are very different from a longer-term subscription line of credit, which may indeed have a significant impact on a fund’s IRR and risk characteristics.”In some cases, subscription lines of credit manipulate the mechanics of the IRR calculation, improving the fund’s stated IRR.

She has been an adjunct faculty member at New York University, a research fellow at the Hebrew University of Jerusalem, and a member of the 420 Italian National Sailing Team.IRR may be too easily manipulated. It is collateralized by a pledge of the right to call and receive capital contributions from the fund’s investors. Puca is licensed as a CPA in California and New York. Instead I add debt capital.

Portfolio companies generate it directly through guarantees and debt serviced, while private equity funds generate it through subscription lines of credit guaranteed by the investors’ capital commitments.To obtain debt financing, a portfolio company must demonstrate that it has a well-developed business and can service its debt obligations — qualities that make it a potential target for leveraged buyout funds.With portfolio companies in their earlier stages, the source of any cash distribution is an important consideration for investors: Is the distribution a true “dividend” or a return of capital? If the return on the investment exceeds the cost of the debt then I’ve increased the return on equity, but (1) I’ve used debt when I could have used equity instead, (2) increased my performance fee, (3) reduced my investors’ return on an unlevered basis, and (4) reduced my investors’ return on a risk-adjusted basis.

Private equity firms are highly levered, yet their observed volatility is lower than that of public equity.