Volatility Inhibits PME’s Meaningfulness

A recent post that summarises most of the history of the post-IRR performance calculation and valuation methodologies for the private capital industry has been written by Mr. Jesse Reyes, widely regarded as one of the leading experts of the field.

Mr. Reyes, who introduced with other industry experts 20 years or so ago the Public Market Equivalent (PME) methodology that, together with since inception IRR (SI-IRR) measure, are the current GIPS standards for private equity, sets the critical objective for any meaningful improvement in the space in the Act IV: Do we need another method?  of his piece:

“With these PME tools, you could compare private equity to public markets, alternative assets to public markets, real estate investments to the public markets, but you can’t directly compare these asset classes against each other.”

The effectiveness and the interpretative power of the PME methodologies, seemingly including the latest version from a leading investment consultant and, in extended terms, a leading academic alternative approach, are in fact even more limited than what Mr. Reyes describes because of the noise deriving from market volatility.

Both in the original PME approach that postulates the creation of the “IRR of public markets” and in those approaches that use public market returns to discount contributions and distributions based on the dates of these cash flows, the results are randomly influenced by the volatility of the public markets, possibly to an extent that could make them totally meaningless.