The Tyranny of IRR
28 Pages Posted: 10 Dec 2024 Last revised: 10 Dec 2024
Date Written: December 03, 2024
Abstract
The use of since-inception Internal Rate of Return (si-IRR) may contribute to the prevailing belief that private equity returns are much greater than those of other asset classes. This perception, in turn, drove the sharp increase in capital allocated to private equity funds in developed markets, and their fast penetration into retail investor portfolios. The "Yale model," which posits that superior returns arise from substantial allocations to private equity, is heavily predicated on a si-IRR. Prohibiting the use of si-IRRs, mandating horizon-IRRs with some restrictions, and changing the name so that it does not include the term ‘rate of return’ (e.g., Internal Discount Rate) may help, but essentially whilst the Net Present Value of an illiquid asset is well defined, a rate of return isn’t.
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