When looking at the performance of any alternative fund, there are two common metrics displayed to investors: IRR (Internal Rate of Return) and MOIC (Multiple on Invested Capital).
What is IRR?
IRR, defined in financial jargon, is a discount rate that makes the net present value (NPV) of all cash flows equal to zero. In layman’s terms, IRR is an annualized, compounding rate of return on an investment (similar to the interest rate on a savings account).
What is MOIC?
MOIC is generally a more straightforward metric. This shows an investment’s return as a simple multiple of the original investment. An example would be an investment that’s doubled in value would have a MOIC of 2.0X, whereas an investment that has neither gained nor lost any value would have a MOIC of 1.0X.
IRR vs. MOIC
These two metrics show different sides of the same investment, but can certainly be used to “fact check” one another.
An example of this relationship would be a fund that, after one year, had returned a 10% gain. Then, in theory, the IRR would be 10%, and the MOIC would 1.1X. If, after five years, the same investment has returned a 50% gain, then, again in theory, the IRR would be 10% and the MOIC would be 1.5X.
How to calculate fund performance on sold assets
Calculating fund performance on assets that have been sold is a relatively straightforward task. It comes down to knowing:
• How much was paid for the asset
• Whether there were any additional follow-on investments into that asset
• How much income was generated from that asset (if any)
• How much the asset was eventually sold for.
This information gives a very standard rate of return for the lifetime of our investment, and from here we can back into a time-weighted return by analyzing how long it took to fully realize the asset since its inception.
Are fund performance calculations an art or a science?
The truth is, it’s a bit of both. There are clearly some fundamental mathematical concepts that need to be observed when calculating performance, but there is also a great deal of inference that’s made when it comes to the intrinsic value of unrealized assets.
At a basic level, the two most important things to know are:
• Has sale of fund assets resulted in a gain or a loss?
• What is the current value of my existing, unrealized assets?
The artistic work comes into play when it’s time to put a value on currently-held, unrealized assets. For assets that are traded in a public marketplace, such as stocks and cryptos, it takes just a few minutes to find the current market value. However, when the assets are private and/or there is a relatively limited flow of information surrounding these assets, then it becomes a game of inference.
The best valuations on any alternative investment are accompanied with tons of supporting research. Having a clear picture of the current cash flows of any given asset along with a detailed account of what may impact future cash flows for that asset will help to create a compelling valuation. This particular aspect of the performance calculation matters just as much as the rest of the process, simply because we want to know the answer to one vital question:
If we were to sell this asset today, then how much would the market pay for it?