CAIA L2 - 7.5 - The Risk and Performance of Private and Listed Assets Flashcards
Define
2 forms of
Asset illiquidity
7.5 - The Risk and Performance of Private and Listed Assets
time needed at fair prices
price if done quickly
(1) the time needed to close the position if the price is unaffected
(2) the price at which the position is closed if it must be done quickly
over the past several decades, the overall liquidity for U.S.
equities has increased signi icantly due to increases in trading activities. At this point, illiquidity is only an issue for smaller common stocks.
7.5 - The Risk and Performance of Private and Listed Assets
Compare and explain
two ways to justify the significant difference in performance between the NCREIF Property Index (NPI) and the NAREIT Index
7.5 - The Risk and Performance of Private and Listed Assets
NCREIF Property Index (private properites)
< 250bps annualized (25y)
NAREIT All Equity Index (public, listed REITS)
- The NAREIT index reflects information efficiency as it adpats quickly to actual changes in value
- The NAREIT index was heavily impacted by US stock market volatility, while the NPI returns showed lower volatility and may have been a more representative reflection of the real estate markeet and market transactions.
7.5 - The Risk and Performance of Private and Listed Assets
Formula
Interim Internal Rate of Return (IIRR)
7.5 - The Risk and Performance of Private and Listed Assets
PV of Distributions - PV of contributions + PV of NAV = 0 (using i = IIRR) ; NAV replacing final distribution:
∑D/(1+IIRR)−∑C/(1+IIRR)+NAV/(1+IIRR)=0
A potential issue with the IIRR calculation is it can have multiple solutions because of multiple sign changes in cash flows.
7.5.3 - The Risk and Performance of Private and Listed Assets
Formulas
Cashflow multiples that are useful for measuring performance:
Distribution to paid-in (DPI) ratio
Residual value to paid-in (RVPI) ratio
Total value to paid-in (TVPI) ratio
7.5 - The Risk and Performance of Private and Listed Assets
Distribution to paid-in (DPI) ratio. Cumulative distributions to investors relative to the total capital drawn from investors. DPI captures the realized return.
DPI = ∑D / ∑C
Residual value to paid-in (RVPI) ratio. Total value of the unrealized investments (measured by NAV) to the total capital drawn from investors. RVPI captures the unrealized return.
RVPI = NAV / ∑C
Total value to paid-in (TVPI) ratio. Cumulative distributions to investors plus total value of unrealized investments to the total capital drawn from investors. TVPI captures both the realized and unrealized return.
TVPI = DPI + RVPI
TVPI = (∑D + NAV) / ∑C
7.5 - The Risk and Performance of Private and Listed Assets
Formula
PME ratio
7.5 - The Risk and Performance of Private and Listed Assets
PME ratio compares cash flows in the future (FV; at time “T”)
PME ratio = [ FV(D) + NAV ] / FV(C)
FV(D)=FV(distributions) =∑ [ (Dt×I) / It ]
FV(C)=FV(contributions)=∑ [ (Ct×I) / It ]
I = return on a market index time T
It = return on market index time t
From time t to time T
EXAMPLE: PME Ratio
Assume a PE investment has the following cash flows from
years 1 to 3:
−200, +150, +175
The Year 3 NAV of the fund is 100.
Also assume over the same period that a public equity index has values of
240, 280, 260
Calculate the FV(D), FV(C), and PME ratio over the three-year period.
Answer:
FV(D) = [150 × (260 / 280)] + [175 × (260 / 260)] = 314.29
FV(C) = 200 × (260 / 240) = 216.67
PME ratio = (314.29 + 100) / 216.67 = 1.91
A PME ratio higher than 1.0 indicates out-performance relative to the public market.
7.5 - The Risk and Performance of Private and Listed Assets
Explain
3 ways
to calculate
IRR / IIRR for a portfolio
(of assets in a PE fund)
7.5 - The Risk and Performance of Private and Listed Assets
Equally Weighted IRRs or IIRRs: average of IRR
Commitment-Weighted IRRs or IIRRs: commitment weighted average of IRR
Pooled Cash Flows for Weighting IRRs or IIRRs: Generate one cash flow and calculate IRR
7.5 - The Risk and Performance of Private and Listed Assets
3 key empirical findings
regarding
PE fund performance
7.5 - The Risk and Performance of Private and Listed Assets
- Performance of venture > buyout
- Out-performance and persistence for PE funds: before 2000 > after 2000
- Early-year venture capital = good risk-adj return; risk-adj PE = low.
7.5 - The Risk and Performance of Private and Listed Assets
two propositions Investors should keep in mind when considering how much to allocate to assets in private relative to listed markets
- Restrict use of private structures only to invest in asset classes with outstanding investment opportunities that are managed by exceptionally talented GPs. A truly outstanding manager or investment opportunity will still be able to earn investors high returns regardless of high fees.
- Listed structures should be used when GPs have only average skills or when markets have only average investment opportunities. Listed structures provide more investor protections and lower fees, which makes sense when pre-fee returns are expected to be relatively low.
LO 7.5.7
Challenge of comparing public and private real estate returns
Priavte real estate returns tend to not be based on market prices and REITS and private real estate tend to vary in terms of leverage used.
1 main factor:
* Higher fees of Private
Other factors:
* leverage
* risk
on a risk-adjusted basis, private real estate does not seem to offer illiquidity premiums.
Evidence exists which shows that public real estate has outperformed private real estate, particularly when the higher fees on private real estate are considered.
Private investments tend to carry higher initial fees and expenses with a limited time frame for investors to recover those costs, whereas public investments have no term limits and have lower initial offering expense.
Subscription-secured line of credit and its effects on IRR
Financing source that uses investor capital commitments as collateral.
Across periods where fair value rises over time, the IRR will be higher when a SLOC is used because invested capital used to calculate IRR is lower. Where fair value falls over time, the IRR will be lower when a SLOC is used.
LO 7.5.3
