April 23, 2019
Why is Public Market Equivalent (PME) Important?
At Cobalt, we work with clients that believe that intelligent data analysis powers effective decision-making. Moreover, these limited partners (LPs) often value the insights they derive from regular performance measurement and benchmarking. Private markets investments have always presented unique challenges when measuring performance relative to other asset classes. Investors in private markets funds make an upfront commitment to a blind pool of capital. Then, managers call commitment over time (typically over the first 3 – 5 years of a fund’s life) as the fund manager sources investments. Likewise, managers distribute proceeds after selling investments. This dynamic creates an irregular stream of cash flows, necessitating the use of the internal rate of return (IRR) as the primary performance measure.
Conversely, public markets returns are commonly quoted as a time-weighted return (TWR). TWR is not comparable to an IRR. This creates difficulties with performance comparisons between private markets and public markets. A TWR does not account for the timing and sizing of cash flows, as an IRR does, making TWR ill-suited as a performance metric for private markets funds. For investment teams compiling board reports or evaluating asset allocations, this can be a major headache.
The Public Market Equivalent (PME)
Enter the public market equivalent (PME). The goal of public market equivalent (PME) is simple: to translate a public markets return into an IRR-like metric that accounts for the irregular cash flows and fluctuating capital-at-work of a private markets fund. Public market equivalent (PME) analysis allows investors to make direct comparisons between private markets funds and public benchmarks. For instance, when presenting to an investment board, public market equivalent (PME) allows a limited partner to demonstrate the opportunity cost benchmark of investing in the private markets. LPs are also leveraging this knowledge to evaluate an increase in their private markets allocation. The intuition behind the public market equivalent (PME) is simple. The implementation, however, can be more challenging.