Benchmarking Private Equity: The Direct Alpha Method

Abstract

We propose a simple and intuitive measure of the annualized excess return of investments in private equity (PE) funds, as well as in similar vehicles that hold hard-to-value assets. Our ‘Direct Alpha’ method is well-founded in theory and dominates the existing approaches to convert fund lifetime returns into inputs amenable for portfolio-wide optimization. Existing Public Market Equivalent (PME) approaches are either heuristic or involve significant approximation errors. Using real-world PE fund cash flow data, we juxtapose Direct Alpha against nearly all PME methods that have been in broad use.

Keywords: illiquid assets, private equity, performance evaluation, modern portfolio theory

JEL Classification: G11, G12, G23, G24